By Katherine Pearce
Posted in www.advent.com, 19 August 2020.
In the years following the 2008 financial crisis, private credit, also referred as direct lending, experienced a steady climb, outpacing other alternative investment vehicles. Yet, transaction sizes were always on the smaller side, compared to other investment types; as Bloomberg notes a $500 million transaction was considered a “mega-deal.”1 Now, as we experience shifts in the market due to the global health crisis, investors and borrowers alike are seeking much larger private credit transactions. Should this sector continue to grow, these funds will require specific operational expertise and technology to look and feel more institutional, as well as provide the transparency and due diligence that investors are accustomed to.
At the start of the health crisis, several analysts wrote-off private credit arguing highly leveraged businesses would not be able to manage a painful fallout during an economic downturn.2 Yet, private credit is more nimble and bespoke compared to standard bank loans. With uncertainty around the future of a business and the slashing of interest rates, large tier banks are prudent in choosing which firms to lend to, opening the door for direct lending. 1
As the private lending market expands and transaction sizes increase, funds should focus on incorporating institutional-quality investment and operating models that the hedge fund industry previously undertook to manage risks, and deliver the necessary services to investors. For example, consider how loans are currently managed:
- Loan templates are easily built in spreadsheets, with tweaks to reflect each deal’s specific terms;
- Yet, the popularity of templates only augments calculation errors, as these issues become ingrained and the templates are disseminated and reused across the organization
To mitigate the risks from manual spreadsheets, funds require technology solutions that are scalable, repeatable, resilient, and automated –particularly as positions need to be commingled with other assets, or other accounting systems. The use of spreadsheets and the lack of operating scalability to manage private credit investments is untenable, mainly as deal volumes expand and the definition of a “mega-deal” grows exponentially.
According to Robin Wigglesworth of the Financial Times, there is strong evidence that private capital is here for the long term given low interest rates, the “burden” of being listed as a public entity, and the trend of pension plans to include private equity investments. 2 Fueled by this current ecosystem, private credit lending will, for the foreseeable future, experience growth. However, as other alternative asset sectors have discovered, progressive institutionalization of the investor base comes at the cost of more stringent compliance, operational, and service demands. With competition intensifying, private credit managers will have to work harder to attract investor allocations. The success stories will be those firms that can support their clients with an automated, institutionalized operating environment.
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1. Butler, K. and McGovern, R. (2020, July 28). Billion Dollar Deals See Private Credit Step Out of the Shadows. July 28, 2020. Retired from: https://www.bloomberg.com/news/articles/2020-07-28/billion-dollar-deals-see-private-credit-step-out-of-the-shadows
2. Wigglesworth, R. (2020, June 29). Why private capital will benefit from the crisis. Financial Times. July 28, 2020. Retired from: https://www.ft.com/content/b104940f-bf3b-4090-bcb2-50aef67da564