Private Credit: The Loan Lifecycle (and Operational Implications)
This week’s post dives into the fundamentals of negotiated loan agreements and their (operational) implications. As many of you know, the private credit space has drastically accelerated in the last two years. As more folks adopt this asset class (i.e., hedge funds are increasingly adding syndicated and non-tradeable credit strategies), larger firms with sufficient scale will seek operational efficiency.
In addition, there is an interesting trend around consumer loans now being funded by a growing corner of the private credit world (a la asset-based finance): Elliott recently purchased Klarna’s UK-originated “Buy Now Pay Later” (BNPL) €30 billion loan portfolio, KKR had snatched up PayPal’s €40 billion BNPL loans in 2023, Blue Owl has recently agreed to purchase $2 billion of consumer loans from Upstart via Atalaya (the private credit firm Blue Owl recently acquired), and Apollo’s structured credit originator (Atlas SP Partners) plans on providing debt financing for loan purchases. Said differently, infrastructure is almost a prerequisite for the high-volume consumer loans these firms will be managing and monitoring, and it will be interesting to see how the financial technology market will grow and mature alongside this trend.
Consumer loans aside, take, for instance, a delayed draw term loan: the borrower has the optionality to access funds in multiple installments (with interest accruing only on the individually drawn tranches). This is unlike a vanilla term loan in which the entire amount is disbursed upfront. Moreover, there are nuances around whether the loan is syndicated or not – simply put, syndicated loans are suited for larger financing needs and will involve multiple lenders providing funds to a single borrower; syndication will distribute the risk across multiple lenders (issuers). On the other hand, bilateral loans negotiated between one lender and one (portfolio) company typically offer more flexibility and efficiency, whereas syndicated loans, or loans involving pooled investors, often involve more complexity. Furthermore, in terms of administration, syndicated loans typically have an agent bank (i.e., lead arranger) managing the loan on behalf of the syndicate, whereas bilateral loans are often simpler transactions managed directly between the lender and the borrower themselves.
For a delayed draw loan, the underlying motivation varies, running the gamut from a portfolio company’s project that entails phased-funding requirements to another company’s milestone-based risk management practices to avoid overborrowing. What’s ultimately unique about loan instruments is that they don’t follow a fixed settlement cycle – the funding memo from the seller will contain the trade-related information. The funding memo will include important attributes such as (but not limited to):
Date – the funding memo’s date implies the settlement date.
Buyer – the loan buyer.
Seller – the loan seller.
Trade Date – the trade or execution date of the loan.
Credit Agreement – the negotiated, bilateral agreement typically contains the issuer and the tranching.
Agent Fee – this is the fee charged by (typically) the brokering bank providing the agent notice(s).
Facility – the loan type.
LoanX ID – the LX identifier is a unique identifier in the syndicated loan market to track and identify specific loan facilities; they’re similar to how ISINs function for bonds and equities. LX IDs, thus, won’t be necessary for negotiated, bilateral agreements.
Global Commitment – the total commitment amount for the loan.
Paydown Amount – any paydown will affect the original amount.
Original Amount – the share of outstanding debt value that belongs to the buyer at the time of the agreement’s execution.
Sale Amount – the share of the outstanding debt value that belongs to the buyer during the settle date of the trade: the sale amount is equivalent to the paydown amount subtracted by the original amount.
All-in Rate – a tabular grid of data that reflects the interest paid by the loan borrower and how those rates are computed (and variable rate schedules may also be involved).
Most of this information is programmatically captured – increasingly, there are software solutions to parse semi-structured and unstructured documents and PDFs and ingest these fields and their respective values. Namely, think vendor offerings like Canoe or proprietary solutions leveraging open-source approaches: the latter would likely involve vision-based Large Language Models (LLMs).
Today, many private credit firms capture the terms and conditions of these bilateral agreements in Excel templates. From a portfolio monitoring perspective, the transparency into the economic events of loans in that firm’s portfolio will become increasingly inefficient to oversee at scale (i.e., monitoring various loans’ economic events across portfolios and complex legal entities, monitoring covenants, managing risk, tracking physical collateral or any asset-based collateral, ensuring oversight of any restructurings, etc.).
For instance, let’s walk through sample economic events of a delayed draw loan. Imagine a fintech company, Payments Unlimited (PU), is looking for venture and debt funding: PU secures a global commitment of $1 billion from Peak Private Credit (PPC). For simplicity purposes, assume that the issuer is just a single entity from PPC; in practice, at a global commitment of $1 billion, there would likely be multiple issuing legal entities in contract with the borrower, PU. Here are some sample lifecycle events to help illustrate some complexities:
February 01, 2024: the credit facility contract is captured.
March 01, 2024: there is an initial drawdown from the credit facility of $1 billion. A fixed interest rate of 4% quarterly is captured.
June 01, 2024: a rollover event takes place, with the terms and conditions altering to anchoring at the CME SOFR quarterly, so a variable rate is now in place. This credit contract also captures PU’s prepayment with interest of $200 million.
July 01, 2024: the commitment amount is rolled over, with interest, to another contract.
By extension, you could imagine more complex events (or transactions) could also take place, such as a restructuring event of some sort – for instance, there could be equity capture in a new contract that PPC would want tied to the original credit facility contract (and all subsequent credit contracts), so any debt-for-equity swap is effectively traced to this original deal in the event PPC (the lender) is able to convert some or all of their debt into equity ownership of PU (the company or the borrower).