Fund financing 2.0

by Phil McKendry, Hazeltree 24 April 2024

During the past decade, the fund finance market has experienced explosive growth, driven by investors seeking alternative avenues for deploying their capital, beyond the confines of public markets. According to McKinsey’s global private markets review from March 2023, this surge has led to a substantial expansion of the private markets, ballooning to an impressive $11.7trn in size. Investors who ventured into the private markets have subsequently reaped the rewards, enjoying robust performance across various asset classes.

Amid a backdrop marked by elevated interest rates and the departure – or compelled divestiture – of three major financial providers, the ability and willingness of banks to extend credit have faced obstacles. Regulatory capital requirements and a reduced appetite for risk, particularly when it comes to middle-market participants, have posed unique challenges. In this environment, private credit is well poised to step in and fill the void. According to Preqin, a significant uptick in private credit AUM is expected at an impressive CAGR of 11.1%. Its projections indicate that the private credit market is poised to nearly double in value, reaching a substantial $2.8trn.

In a CNBC interview in December 2023, Ken Kencel, CEO of Churchill Asset Management, offered an insightful perspective. He accurately characterised the current period as a “golden age” for private credit. Kencel noted that the previous decade had seen the institutionalisation of private credit, but he anticipates a significant shift towards its democratisation in the upcoming decade. This transformation is driven by the vast pool of roughly $180trn in unallocated capital held by retail investors, which alternative asset managers, including private credit, stand to benefit from. The unfolding landscape promises a dynamic and promising future for private credit.

The fund financing options available to GPs have also undergone significant evolution in terms of both types and complexity. The options available include subscription line facilities, NAV and assets lines, and even hybrid structures that combine elements of these instruments. Such diverse financing solutions offer GPs increased flexibility, enabling them to fund deals, leverage investments to enhance returns and fulfil everyday liquidity requirements.

Tracking, monitoring and executing credit transactions have become complex tasks for private credit lenders and borrowers alike. C-suite executives and fund accountants are tasked with the responsibility of meticulously tracking the various facilities; comprehending the intricate terms of agreements, calculating and monitoring the often varying borrow base requirements imposed by different lenders. This operational intricacy can be a significant challenge.

Accuracy is paramount in this process, as any oversight or breach in terms, fees or conditions can lead to substantial fines and other adverse consequences. The multitude of variables involved makes centralised management a formidable challenge for GPs.

Moreover, GPs must have a real-time understanding of their available credit lines, as any liquidity crisis could have far-reaching implications. Historically, bank reporting on credit facilities was limited, with some reports even generated in basic formats like Excel or PDFs, often on a monthly basis. This lack of transparency created a blindspot for GPs, necessitating the development of in-house shadow accounting systems, typically reliant on Excel, which often contained gaps due to the absence of benchmark data feeds required for accurate interest and fee calculations. The absence of a centralised system to consolidate balances, forecasts and available credit has compounded these challenges significantly.

Additionally, it’s crucial to note that each lender maintains its own unique format and specific documentation requirements for capital drawdowns and repayment notifications. Many borrowers engage with multiple lenders simultaneously, making the collation of pertinent information, securing the right signatures and maintaining a comprehensive audit trail a labour-intensive process prior to submission.

Fund financing options available to GPs have also undergone significant evolution

Phil McKendry, Hazeltree

Private credit managers face the formidable challenge of maintaining meticulous forecasts to predict and calculate vital metrics such as coverage ratios, LTV ratios and various other key performance indicators. Additionally, they must remain agile to respond promptly to redemptions and unforeseen events. The critical task of monitoring the credit risk associated with underlying borrowers or assets is both intricate and demanding.

In today's technologically advanced landscape, the burden of these operational tasks can be significantly alleviated through automation. Therefore, it is imperative that private credit lenders implement robust systems to monitor cash flows effectively. These systems serve as a sentinel, capable of swiftly detecting early warning signs, including delayed or defaulted interest payments and repayments. Leveraging technology to streamline these processes not only enhances efficiency but also bolsters risk management practices.

Role of technology

The encouraging news is that, as fund finance markets have evolved, so has technology. The capabilities now accessible to GPs and top-level executives for efficiently managing these operationally risky processes are maturing, thanks to a select group of technology vendors.

Cloud-hosted SaaS fund services platforms have emerged as game-changers. These solutions seamlessly centralise all cash balances, integrate data from various systems, and generate forecasts – all of which tend to be neatly presented on a single dashboard, ushering in a level of transparency previously unattainable. The fact that such platforms can be hosted in the cloud ensures swift and hassle-free implementation across different locations.

Building a comprehensive tech stack not only serves as a single source of truth for cash and forecasting transparency, but also empowers users to conduct transactions based on the latest available information, including intraday balances. This capability extends to interacting with multiple banking partners without the need to log into each bank’s portal individually.

The best-in-class solutions can offer a dedicated credit management product seamlessly integrated with transaction manager and liquidity and cash planning tools. This centralises all credit agreements, whether on the lender or borrower side, and meticulously tracks the terms and conditions associated with each agreement, including thorough borrow-base monitoring. It is particularly important to not only track borrow base but also integrate it into the liquidity planning solution, enabling borrowers to take prompt action when it falls below current credit facility limits.

Other benefits of these fund finance platforms include the ability to handle multiple financing series, incorporate benchmarks and accurately calculate daily accruals while tracking various types of fees. Its sophisticated optimisation presents information concisely and generates cash transactions for interest repayment and notional draws.

Crucially, the right fund finance software can automate the generation of lender notices, tailoring them to client letterhead templates and digitalising these bespoke lender notifications, including the application and approval of necessary signatures. This not only eliminates the cumbersome and operationally risky task of manual processing but also establishes robust, controlled processes while systematically capturing a comprehensive audit trail.

Furthermore, using such a platform streamlines the often time-sensitive process, reducing the need for staff to physically collect signatures in the office. This efficiency becomes paramount when swift access to capital is essential, especially in last-minute deals that demand speedy payment.

Overall, technology stands as the catalyst for a profound transformation in how fund managers conduct their operations. It empowers managers to implement systematic controls, mitigating risk and averting the financial penalties, fines and reputational damage that can result from manual oversights, such as tracking terms or late paydowns. Technology simultaneously streamlines diverse processes, enhances operational efficiency and affords staff the opportunity to redirect their focus toward more impactful tasks.

This strategic shift not only enables scalability but also aligns seamlessly with the current market dynamics, indicating a promising trajectory of sustained growth. It becomes abundantly clear that harnessing the right technology is instrumental in achieving the desired scalability in this evolving landscape. To find out how Hazeltree’s Fund Services platform can help you on that journey, do not hesitate to get in touch.

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