Bank Debt: Investment Strategies and Technology Enablers
Yannis Sardis, 11 November 2021
Yet another unfortunate by-product of the massive reduction in global economic activity resulting from the (ever present) COVID-19 pandemic, has been the significant increase in the volumes of non-serviced bank debt, a trend that may be sustained in the years that will follow the crisis itself. The distress that the private debt sector experienced mainly characterized the cyclical (yet not exclusively) industries such as energy, travel, aviation, retail consumption, restaurants, hospitality, and entertainment, among others. Even if one assumes a default rate of single digits for the outstanding consumer and SME loans market, the flow of non-serviced debt is expected to continue being disturbingly high.
Although the shape of the pandemic-induced recession, the scale of the resulting unemployment and the gradual reset of the consumer demand have started to partly crystalize, at least with the data sets we possess so far, the outbreak certainly keeps sending the debt defaults soaring and consequently creating long-term structural shifts rather than just short-term market dislocations.
Bank Debt and Alternative Strategies
Banks, being the core holders of the aforementioned defaulted debt, need to continue reducing their credit exposure and strengthen their balance sheets, to effectively remain solvent.
As such they provide the supply side of the equation, with the demand side being occupied by institutional entities which focus on alternative investment strategies, including distressed debt, and wish to purchase high quality credit risk, effectively manage it as a mispriced asset and aim to deliver attractive risk-adjusted returns to a growing audience of interested investors, whilst often also providing capital to consumers and SMEs.
Investment managers who employ such credit and private debt products, consider them amongst the most challenging investment types to account for, mainly due to the resources, the operational expertise and the technology capabilities required to both manage and account for the assets, as well as provide detailed look-through to the underlying assets and fulfil suitably all the ongoing servicing requirements.
Investment Management Challenges
Considering that legacy portfolio accounting systems and spreadsheet-based processing are inefficient, resources-heavy and prone to errors, the technology systems needed for such asset packages include Accounting, Valuation, Reporting and Compliance modules, via automated and scalable processes.
The typical challenges that investment managers of such assets face evolve around:
- Unique terms and conditions of debt, related to capital and interest payments
- Managing delayed payments and keeping track of delinquent interest
- Projecting future cash flows and payments aging
- Reconciling cash flows from bank statements
- Recording fees and expenses in relation to debt servicing
- Accounting for amortization and discount on the purchase of the debt facilities.
With a solution that can provide global event processing and administration for all debt types and related credit activities, investment managers and asset owners can:
- Register and keep track of debt terms and conditions
- Calculate and account for interest accrual and amortization
- Easily book expenses and fees against debt
- Monitor future cash flows resulting from interest and principal repayment
- Monitor counterparty and debt quality exposure
- Reconcile cash flows and bank account statements with internal books
- Simplify the handling of overdue interest and principal payments
- Eliminate the support of legacy solutions by utilizing SaaS offerings
- Eliminate spreadsheets and automate the daily debt processing.
Such a system would consequently empower its users to:
- Manage effectively the outstanding debt portfolios, no matter their level of complexity
- Seamlessly account for their financial, position, accrual and cash-flow reporting needs
- Improve the calculation accuracy and reduce the risk in processing complex instruments
- Eliminate the need for multiple systems and processes to manage different debt types.
As it is the aim in most complicated financial systems, the role of a smart software solution is to:
- Facilitate and support the manager in converting big sets of available distressed debt data into profitable investment strategies. Such a structuring process requires a number of steps, ranging from a client segmentation to a sophisticated modelling for cash-flow projections
- Monitor the risk-adjusted profitability of such investment strategies, represented by different metrics and tenors, and segmented by distinct investor types and classes, depending on the idiosyncratic characteristics of the debt basket.
Such a platform would provide a comprehensive, multi-currency, all-in solution for either:
- Complementing the current systems of established market participants who focus on the debt investment management space, or
- New market entrants who wish to establish their presence in new geographies and focus on the investment management side of the debt sector.
FINVENT Software Solutions is a provider of financial software applications and custom engineering services. Finvent is the sole SS&C Advent distributor globally and its products are integrated with those of SS&C Advent.
SS&C Advent ‘Geneva’ is a proven solution for Asset Managers, Hedge Funds, Fund Administrators, Prime Brokers and Mutual Funds that require a high level of operational efficiency and easy access to real-time data. Geneva offers a comprehensive instrument coverage, a full general ledger, and industry standard integration tools that enable firms to manage complex investment vehicles, multiple investment strategies, and tiered fund structures. With deployment on premise or in the cloud, Geneva is a flexible and highly scalable platform that more than 375 firms globally trust for their most complex portfolio management and accounting needs.