The Private Credit Landscape

The Private Credit Landscape is a contribution to CVCA Central from CVCA member John Middleton, Senior Manager, Harmonic Fund Services.

The recent growth in private credit has been rapid and exciting. It took only 20 years — and a financial crisis — to fundamentally restructure the loan market to one where alternative credit is helping fuel a very significant portion of modern North American and European economies.

A loan is no longer just a loan. Alternative credit encompasses a range of private credit categories such as mezzanine financing, direct lending, special situation loans, distressed debt and structured credit — all of which are now available from alternative lenders. And the industry is growing. The numbers are substantial, some say even seismic. Market projections indicate the private credit industry will reach USD $1 trillion in assets under management by 2020.

As the market continues to grow in complexity and size, so too do the operational, administrative and reporting responsibilities of investment managers. With spreadsheets no longer considered to be an acceptable technology platform, managers are looking to service providers to reduce risk, increase efficiency and add value.

But where to begin the search for the right service provider and what kinds of problems might they be able to solve? This article considers some key factors in making that assessment and provides insight into current service models being offered.

What are some key factors to consider?

EY recently reported investors increased their ranking of the ​“ability to handle reporting requirements” by 400% as the most important factor when selecting a private equity firm. In short, a fund eventually may need to reconsider its infrastructure — and not just on its strategic lending decisions. And this decision process will need to focus on the most cost-efficient route to rebalancing them successfully. The below outlines three key categories to consider:

• Technology
  • Scalability: volume sensitive platforms for tracking complex deal structures work only so far before operational risk and labour intensive processes become just too problematic.
  • Complexity: a platform designed specifically for private credit funds and their myriad loan complexities can offer substantial labour reduction and lessen some of the risk involved in the increasingly complex calculus in many private debt deals. E.g., a good provider can automatically track and report European waterfall distribution figures.
  • Customization: customized reports tailored to a fund’s investors, auditor or internal stakeholders can be a huge time saver to a firm and also give an investor greater security via the transparency robust reporting can provide.

• Depth of Knowledge and Service Levels
  • Knowledge: an established service provider should offer a deep bench of staff with loan expertise that knows industry standard practices, provide a reliable service and offer help to solve complex booking or accounting challenges. A good admin will have a deep pool of knowledge at a client’s disposal.
  • Servicing: a loan service provider can provide a full suite of service models that lift out the many layers of tasks in a fund’s back office. As a fund grows, its back office doesn’t necessarily expand that significantly — the admin takes that extra back office volume on board and assumes the increase in operational responsibilities.

• Borrower/​Investor Relations 
  • Reporting: ever-increasing demands from sophisticated borrowers and investors can be easily facilitated by a good fund or loan administrator. Regular NAV reporting, investor due diligence, statements, loan notifications, and an easy to use report portal all assist in giving borrowers and/​or investors the transparency and reporting complexity increasingly required.
  • Investor Due Diligence: fund administrators should offer a suite of services to cover counterparty due diligence, including AML, KYC, FATCA and the like.

What are the basic vendor service operating models?

As with any service offering, delivery models can differ between vendors. For ease of illustration purposes, we’ve broken things out into what are essentially 3 different services. Firms can generally cherry pick from the below, customize one or more of each, or take the entire lot. Below we’ve briefly outlined each category:

• Fund Administration
  • The essentials of a fund administrator’s offering include fund accounting, NAV and performance calculations, investor services and reporting, and management of capital calls and distributions
• Back and Middle Office Support
  • Service providers can be a fund’s back and middle office, including tracking of the loan book and performing any or all of a fund’s back or middle office’s functions.
  • Parameters can vary widely per client engagement and can be as bespoke as required; basics include daily, weekly or quarterly reconciliations with counterparties, including banks, daily P&L and/​or GL reporting.
• Loan Administration or Agency
  • The loan administrator or agent is generally hired by the lender and can act as an independent facilitator of deals particulars.
  • The facility generally sits between lender and borrower and takes over the responsibilities of deal setups and maintenance, lifecycle transactions, the generation and distribution of notices to all parties, as well as managing and settling cash activity.

Summary

The relationship between these service types and our three key factors depends significantly upon a manager’s business model. For example, for a fund with a high volume operation, technology could be quite advantageous to limit volume sensitivity and labour costs. Alternatively, a smaller manager with lower capacity and/​or less complex deals, technology could be less relevant however a knowledgeable service provider could be extremely valuable by providing insight into best practice procedures, AML/KYC outsourcing or simplifying investor or borrower reporting.

Hopefully the above discussion provides some helpful insight into why and what to consider when turning to an external provider in this burgeoning space. Of course, each fund’s process, economics and scale is unique and the right fit can be different for everyone.