Is 2024 the year debt and credit go private?

Inflation and rising interest rates brought an abrupt end to the era of “cheap” money. The decline of mid-market lenders like Silicon Valley Bank and Signature Bank further limited the options that startups and tech companies had for capital. This situation prompts companies to look at alternatives to traditional banks to fund their growth strategies. Private markets sitting on ample capital are eager to fill this market demand and, as a result, are opening their capital reserves to lending. 

Since the financial crisis, banks have adopted a more cautious approach when it comes to extending risky loans. However, in the aftermath of the 2008 recession, interest rates remained unusually low, and institutions like Silicon Valley Bank, which had been a crucial partner for over half of U.S. venture capital-backed enterprises, continued to offer banking services and credit to startups. With the onset of inflation and the subsequent rise in interest rates, a capital shortage emerged, particularly affecting banks like Silicon Valley Bank, ultimately leading them towards insolvency. 

Consequently, this translated into a scenario where there is a significantly reduced availability of capital, and what is accessible comes at a substantially higher cost for startups and venture-backed companies seeking to fuel their growth. As a result, many of these entities have been compelled to shift their focus towards the private markets as an alternative source of much-needed capital. 

According to Preqin, the size of the asset class grew to $1.3 trillion. It took 12 years to get to $1.2 trillion and projections are for the market to double in the next four years. 

This significant growth in volume is beginning to take its toll on a traditionally manual process.   When private equity firms venture into or expand private debt, new challenges are introduced to the back office impacting operations, administrative and regulatory functions. These challenges are due to the unique nature of private debt instruments compared to private equity, and include the aspects listed below. 

Data and Systems integration 

Most private equity systems are tailored to supporting fundraising, dealmaking, valuations and accounting. Private debt instruments require integrating data and systems to manage and track debt-specific metrics, such as coupon payments, interest rates, and maturity dates. This integration can be complex, particularly if the systems were not initially designed to handle debt instruments. 

Currently, the standard practice is to track loans manually on Excel spreadsheets. The front office relies on this process to understand the future or current portfolio income, borrower risk, etc. There are a few solutions available for this, including: 

• Excel 

• Custom Anaplan tables 

• Internal designed applications 

Each of those solutions come with their own risks including data gathering challenges, manual error and application complexity. 

Valuation and reporting 

Valuing private debt investments is often more complex than valuing equity investments, especially when dealing with complex debt structures or illiquid debt securities. Private equity firms need to develop appropriate valuation methodologies and ensure accurate and transparent reporting to the front office investors, regulators and other stakeholders. The front office relies on this data to make investment and loan decisions. Understanding the future or current income of portfolio or borrower risk requires manual effort from the front office. This is not all dissimilar to the back-office environment before the introduction of systems like Investran. 

Cash flow management 

Private debt investments generate cash flows in the form of interest payments and principal repayments. Managing these cash flows and ensuring accurate allocation to investors or different funds can be a logistical challenge. Traditionally, these processes have been carried out using Excel spreadsheets, which, while versatile, are prone to errors and inefficiencies when handled manually. The reliance on manual entry can lead to delays, inaccuracies, and an overall increased risk.  

Investor relations 

Private equity firms that expand into private debt must effectively communicate their debt investment strategies to existing and potential investors. They need to address any questions or concerns related to the new asset class and demonstrate how they plan to manage both debt and equity investments successfully. 

Talent acquisition and training 

Hiring and retaining skilled professionals with expertise in private debt can be challenging, especially in regions or sectors with high demand for such talent. Professionals who can navigate the complexities of private loans help organizations stay compliant with regulations. Firms may need to invest in training programs to upskill existing staff or hire new talent to handle the specific demands of private debt investments. 

Risk management 

Implementing a robust risk management framework to assess and mitigate credit risk associated with private debt investments is essential to protect capital and ensure compliance with regulatory standards. It allows investors to make informed decisions and potentially minimize losses. Private equity firms may need to adopt new risk assessment models and credit analysis techniques suitable for debt instruments. 

To address these back-office challenges, private equity firms should conduct a thorough analysis of their operational capabilities. They may consider seeking external expertise or partnerships if necessary. Investing in technology solutions tailored to handle both equity and debt instruments can also streamline back-office processes and enhance efficiency. A proactive approach to adapt to the unique requirements of private debt can increase the likelihood of success for private equity firms in this new asset class. 

To meet these demands, innovative solutions are emerging in the market, and one such solution is Tenor Digital. Founded by Tony Chung and Jesus Mirabal, seasoned experts. Tenor Digital aims to address the evolving landscape of today’s market. In Tony’s words, “Addressing these challenges requires the right tool for the right job. At Tenor, we use advanced technologies to deliver a calculation engine, data analytics and data visualization, enabling accelerated, informed decision-making in the private debt sector. We provide a “line of sight” into the underlying debt facilities so customers can analyze how to structure a deal for optimal outcome pre-investment and perform scenario analysis and forecasting on the loans to maximize investment outcomes.” 

GFT is well- positioned to support this exponential growth in debt and credit by working with partners like Tenor. Our in-depth business knowledge with our unmatched technical capabilities leveraging the latest innovations in cloud and AI, enables this offering while minimizing risks.