‘I’ll Be There for You’ December 2022 | Issue No. 203 – Fund Finance Credit Availability in 2023: Not Just Banks | Cadwalader, Wickersham & Taft LLP

2022 was a notable yr for banks, however 2022 may even be remembered for the continued rise in personal credit score. The scale and significance of those non-bank lenders grew to become obvious this summer time when personal credit score funds stepped in to shut billions of loans as banks pulled out of the leveraged mortgage market.

The expansion path for personal credit score is properly documented. For instance, Preqin predicts that his AUM of personal credit score will greater than double from his $1.21 trillion within the second half of 2021 to his $2.69 trillion in 2026. I am right here. GFC is now roughly equal to the full measurement of that market. After all, this isn’t an ideal comparability, however it exhibits that non-public credit score has turn out to be an vital supply of capital globally.

Given these tendencies, it’s pure for fund finance market members to contemplate the longer term significance of non-bank lenders available in the market. Up to now, you will need to emphasize the distinction between conventional direct lending and fund finance. For company debtors, the attractiveness of single-lender acquisition offers is especially engaging right now available in the market. First, debtors, who’re largely sponsors, can commerce figuring out their funding is locked in. This has been a problem this yr. Or a small group can serve a borrower’s wants significantly better than a syndicate.

Fund finance doesn’t have the identical challenges. Execution works due to the depth of the connection, pre-commitment credit score approval, and origin-to-hold enterprise mannequin. Our loans will not be structured with the identical value flex mechanism as leveraged loans. Additionally, the vast majority of lending in fund finance (91% in his first three quarters of 2022 deal quantity) is bilateral. Add to this, given the monitor report of old style loans, and it turns into clear that Non-public his credit score does not have the identical issues to resolve.

Due to this fact, if personal credit score is to develop in fund finance, that progress could rely upon what challenges fund finance can resolve for personal credit score lenders. Non-public credit score funds maintain $425 billion in dry his powder, based on PitchBook knowledge. Sponsors receives a commission for capital deployed, so whereas the clock is operating on dedicated capital, important underwriting sources are already in place.

Common fund efficiency in 2022 additionally exhibits that non-public credit score funds will profit from higher diversification. Non-public credit score returns softened in 2022, typically monitoring the broader mortgage market pretty carefully. A fund’s funding publicity could scale back that correlation and assist the fund in each deployment and diversification challenges.

However the reply is I wrote before, unlikely to be obtained from subscription lending. Even with the 1-month SOFR gaining 420 bps up to now this yr and the margins on subscription amenities increasing, unleveraged returns will not be absolutely mirrored. Apart from the hurdle return situation, there are additionally relative worth concerns. Non-public credit score funds at the moment are delivering double-digit returns on main direct lending packages. Second, even with subscription pricing additional expanded, we imagine LP’s debt-based underwriting course of remains to be finest suited to banks. NAV lending is a extra pure match as lending margins higher match personal credit score value of capital. Subordinated subscription debt might be one other avenue for progress in 2023, particularly if the product evolves and banks scale back the prepayment price and measurement of recent credit score amenities.

Then there’s the untapped marketplace for structured fund finance. Financial institution lenders have extra incentive than ever to push for credit score threat switch options. Right here, personal credit score funds, as subordinated traders, can acquire publicity to swimming pools of high quality subscription loans with leveraged returns.

Secured fund debt might be one other potential progress space the place personal credit score funds can fund a various basket of funds with structural subordination and credit standing benefits. The CFO market has been round since his early 2000s, however LPs are extra motivated to search for portfolio administration instruments in his 2023 to assist CFOs unlock liquidity.

As such, we imagine the financial institution’s creditworthiness is safe, however we anticipate fund funding to evolve in 2023, additional leveraging the huge and rising pool of personal credit score capital. I am right here.

* Director, Fund Finance

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