Retrenchment to
Re-tranchement in Private Credit

The GFC ushered in a fundamentally different direct lending relationship. Oxane Partners’ Sumit Gupta sets out the operational challenges that need to be addressed in this new world.

There’s a standard narrative to describe the growth of private credit since the Global Financial Crisis: the asset class stepped in to fill the gap left by commercial banks, who cut lending due to tighter regulations and a reassessment of risk. What followed was not a temporary pullback, but a structural shift in how credit would be supplied to a large part of the economy.

The Basel III framework certainly introduced more stringent capital requirements for banks, meaning they adopted a more conservative approach to lending. Not bound by the same capital and liquidity requirements, private credit was the obvious new avenue for middle market companies.

But the real story is more nuanced. Banks did not retreat from direct lending altogether. They readjusted their position in the capital structure to work alongside private credit funds.

As Oxane Partners’ CEO and Co-founder Sumit Gupta puts it, this is “the retrenchment to re-tranchement story”. Prior to the GFC, he explains, banks were more willing to hold positions across the capital structure.

“Now they are more likely to provide senior financing to non-bank lenders, including private credit funds, rather than underwrite the full exposure themselves”, he says. This is typically in the form of financing solutions such as portfolio financing, warehouse financing, asset-based lending, and fund finance.

As a result, private credit firms are increasingly taking junior positions in the capital structure, while banks remain involved through the senior part of the stack. In that sense, banks have retrenched, but they have also re-tranched. Far from stepping away entirely, they have indirectly helped fuel the growth of the private credit market. Rather than competing directly, banks and private credit funds are often working together to fund different layers of the same capital structure.

This is particularly valuable for private credit funds, which can benefit from the deep origination expertise banks have built over decades of SME lending.

“Banks still have a strong origination capacity”, Gupta says. “Private credit firms can benefit from that strength, with banks often playing an important role in sourcing opportunities and bringing borrowers to the table, while funds provide capital and deal execution alongside them”.

Banks have continued to benefit from the rise of private credit in other ways as well, but different banks are taking different approaches. Some are participating through strategic partnerships. Such as the likes of Citi and Apollo, and UBS and General Atlantic, where banks are combining origination strength and borrower access with private credit capital.

In other cases, they are participating more directly through their own asset management arms. Goldman Sachs Asset Management (GSAM) and Morgan Stanleys Investment Management (MSIM) are both highly active in private credit. “When it comes to the asset management arms of these banks, they are essentially competing with these private credit funds for business”, he says.

Others remain involved through service and infrastructure roles. Even where they are not taking lending exposure, banks continue to play an important role through agency, servicing and back-office support. Across all of these approaches, banks continue to play an important role in the growth of private credit.

The operational frontier

Cooperation that does happen introduces friction into the market. Banks require transparency from funds on issues such as borrowing capacity, for them to pass their own compliance procedures. With funds sometimes working with multiple banks on SME loans, this operational burden adds up.

When private credit funds come under increased scrutiny, see the ‘SaaSpocalypse’, the challenges compound even further.

Rising redemptions from retail-focused funds have been accompanied by demands for increased visibility on valuations, through more frequent NAV reporting.

In March, Apollo announced that it would start reporting NAVs monthly, with the aim of moving towards daily NAVs over time.

With sectors such as SaaS coming under pressure, Gupta says that banks are beginning to look more closely at the underlying collateral for their loans that is coming from private credit funds. That is increasing the focus on how that collateral is valued over time. Banks are demanding more stringent mark-to-market rights over that collateral so they can revalue it as conditions change.

“While there are indications of a systemic risk yet, it’s certainly a wakeup call for banks as well as funds to perform the appropriate due diligence and make sure their underwriting standards are being met”, he adds.

If problems continue, Gupta says that banks will “reprioritise to focus on the larger counterparties”. This could force them to withdraw from some of their smaller loans, leaving private credit funds to take a greater share of those financings.

Regardless, underwriting standards will continue to be tightened, with due diligence from banks going deeper to uncover anomalies in a more proactive way.

Processing the operational burdens that these underwriting standards will impose on banks and funds requires having the infrastructure to facilitate these interactions more easily.

“There is a demand for services to address the issues on both sides, across the entire lifecycle”, he says.

“At Oxane partners, we have built the Oxane Panorama platform over the last 12 years to digitise the data points, allowing us to provide insights for both banks and private credit funds.”

“Our technology exists to serve both ends of the market, and there are very few players in the credit space who are sitting right in the middle like that.”