October 2021: Private Debt and Digital Lending Digest

by Aleksandra Yurchenko

Welcome to the monthly digest about Private Debt and investing in Digital Lending providers. We have hand-picked thought pieces and new information relevant to the topic from the past month. Please, feel free to reach out in case of questions or feedback.

Private Debt

1. Private Debt: A Lesser-Known Corner Of Finance Finds The Spotlight

2. Ares CEO Sees Direct-Lender Financing Deals Reaching $5 Billion

3. Institutional Investors Double Down on Private Assets

4. Private credit remains compelling but is operationally complex

5. Moody’s rating agency warns of “systemic risk” in private credit

1. Private Debt: A Lesser-Known Corner Of Finance Finds The Spotlight

The private debt has become a frontier for many investors in their search for yield. The market has matured and grown tenfold in the past decade with assets under management surging to $412 billion at end-2020. Borrowers in this market tend to be smaller (averaging $30 million in EBITDA) and more highly leveraged than issuers in the broadly syndicated leveraged loan market—most are unrated.

One of the central differences between the private debt market and the broadly syndicated loan market is the number of lenders involved in a transaction. In private debt deals borrowers work more directly with lenders - alternative asset managers, primarily, through their lending platforms. Some lenders have started to move away from traditional first-lien term loans to “unitranche” structures that eliminate the complex capital structure in favor of a single facility.


2. Ares CEO Sees Direct-Lender Financing Deals Reaching $5 Billion

Pandemic-driven boom in mergers is fueling demand for private debt financing. The deal sponsors are increasingly bypassing syndicated loans arranged by banks and turning to direct lenders, large alternative asset managers, such as Ares Management Corporation, usually at a higher cost. Borrowers are willing to pay extra for the flexibility of dealing with a direct lender, speed of execution, confidentiality or a need for unconventional financing. 

Institutional and, increasingly, retail investors are plowing money into direct-lending funds because they offer higher yields than corporate bonds or syndicated loans. These funds can now underwrite deals as large as $3 billion, and the trend towards consolidation among alternative-asset managers will give them even more scale to challenge the banks.

3. Institutional Investors Double Down on Private Assets

According to Schroders “Institutional Investor Study 2021”, 90% of the 750 international institutional investors said their allocations in one or more areas of private assets would rise throughout 2021, mainly for diversification purposes. Impact investing and private debt are in the top three assets by allocation (29% each), after private equity (37%) and infrastructure equity (32%). 

Private debt demonstrated consistency during the pandemic, which was “the first true proof-of-concept for private debt”, and is added to portfolios by investors predominantly for diversification purposes, driven by its ability to adapt in face of adversity and volatility. Fees, lack of liquidity and complexity remain the primary issues for investing into private assets.

4. Private credit remains compelling but is operationally complex

As more alternative fund managers explore the yield opportunities in private debt, one of the risks is introducing too much complexity to their middle- and back-office operations. Outdated accounting and portfolio management systems or insufficient internal resources for tracking individual loan performance increase that risk.

Some of the operational challenges for private credit investors include:

  • ensuring that every moving element of the portfolio works in sync and leverages the same clean data set, making the highly fragmented data more transparent;
  • lack of standardized processes, which results in necessity to process loans manually, dealing with quickly changing terms, irregular cash flows, and challenges with reconciliations;
  • effectively tracking performance of loans and monitoring loan defaults and amortization of loan discounts.

Additionally, there’s limited space for standard fee structures, and more individual terms being negotiated. Hence, the cash flow movements across multiple fee structures and customized waterfall and carry structures terms must be factored in properly.

5. Moody’s rating agency warns of “systemic risk” in private credit

Private debt had emerged as a “new frontier for credit investors as they search for yield” with the market growing tenfold in the past decade. The growing investor base, a lack of available data, and the distribution of debt across lending platforms make it hard to know how much risk there is in this market—and who holds it. At present the vast accumulation of debt and financial assets is being sustained by ultra-low interest rates. But this regime is now coming under great pressure because inflation is increasing at rates not seen since the 1970s. Coupling the higher degree of leverage among smaller companies, and rising interest rates introduces a higher degree of risk going forward, which may be difficult to quantify.

Digital Lending

1. Who makes money in the Buy Now Pay Later business?

2. UK Treasury Launches Consultation on Regulation of ‘Buy Now, Pay Later’ Financing

3. Are there better ways to help consumers tackle social and environmental problems?

4. StanChart Enters BNPL Space With Atome Investment

5. What is Crypto-Lending?

1. Who makes money in the Buy Now Pay Later business?

Typical BNPL purchase is structured in three payments where the first payment is paid at the time of the purchase. BNPL firm finances ⅔ of the product in the coming 60 days period, and gets a high interest rate in exchange. Although quite high, the interest is justified, as BNPL providers are exposed to significant costs as well. Firstly, there is the payment processing fee they need to pay to process payments from customers' debit or credit cards when the customers make the instalments. Secondly, some customers will miss their instalment payments altogether. It is the BNPL provider that bears the risk as they have paid the merchant at the time of the purchase.

The ultimate profitability of BNPL firms is most sensitive to changes in MDR (Merchant Discount Rate) paid by the merchant. Competitive pressures set the MDR on a downward trajectory making it difficult for smaller BNPL companies to survive. Most successful companies capture the relationship with the customer and lead the customer to the discovery of the product they want to buy, and so they bring additional value to the merchants who are willing to pay for lead generation.

2. UK Treasury Launches Consultation on Regulation of ‘Buy Now, Pay Later’ Financing

The UK Treasury has published a consultation paper on policy options for regulation of “buy-now-pay-later” companies, which is aimed to address shortcomings in the regulation of the UK consumer credit market, particularly in light of recent innovations. Firms that offer BNPL products to merchants currently benefit from an exemption from regulation under the UK consumer credit regime. That allows lenders to offer interest-free credit on an unregulated basis subject to specific conditions. Considering that the value of BNPL transactions in the UK more than tripled in 2020, to more than £2.7 billion, the Treasury has initially proposed an outright removal of the exemption, but later reconsidered to limited regulation, taking into account the potential benefits of BNPL products to consumers and ecosystem. 

The key themes of the BNPL rules proposed by Treasury include disclosure standards for BNPL products, creditworthiness assessments for BNPL purchases, and the treatment of “small agreements” (transactions below £50). The Treasury will be accepting feedback on the suggested

3. Are there better ways to help consumers tackle social and environmental problems?

A new study from the Universities of Birmingham and Southern Denmark shows that the lenders of online microlending platforms were more interested in 'emotional returns' rather than financial profit from their loans. Through storytelling, imagery, platform design and communication, the online microlending platforms nurture a feeling that genuine change is possible through affordable actions. They mobilize responsible consumers and inspire them to more actively participate in efforts to tackle social and environmental problems, such as climate change.regulations till 6 January 2022.

4. StanChart Enters BNPL Space With Atome Investment

Standard Chartered has entered into a 10-year multi-product strategic partnership with «Buy Now Pay Later» (BNPL) brand Atome to deliver a wide range of financial services to consumers and merchants across key markets in Asia. The partnership includes a planned $500 million financing to support Atome Financial to expand its regional ecosystem of merchants and customers across Indonesia, Malaysia, Singapore and Vietnam in the next few months. 

Atome was launched in 2019, and currently partners over 5,000 online and offline retailers in nine markets. It also operates digital lending platform Kredit Pintar in Indonesia. The BNPL firm has recently closed a $400 million Series D financing round at more than $2 billion valuation.

5. What is Crypto-Lending?

Cryptocurrency has become increasingly popular over the past decade, and a new type of financial offering, crypto-backed loans, has emerged along with it. Crypto-backed loans are secured loans that use digital assets like bitcoin as collateral. Crypto-backed loans can be found on marketplaces like BlockFi, Binance, and Celsius. The platform of your choice will calculate how much cryptocurrency is needed as collateral, you'll deposit said amount, apply for the loan, and receive your money when it has been approved.

Some of the pros of crypto-lending include:

  • No need to undergo a credit check to qualify for a crypto-backed loan; 
  • Immediate distribution of funds by crypto-lenders, unlike traditional lenders.

The potential drawbacks are:

  • Restricted eligibility as certain digital assets might not be eligible for loans;
  • Lack of liquidity - access to your assets will be limited until you pay off the loan's balance;
  • Exposure to higher risk due to lack of regulation - Crypto-backed loans aren't insured, so you aren't guaranteed compensation in the event of something like a security breach.

Kilde is a regulated investment platform for alternatives. We operate as a two-sided platform connecting institutions / HNWI with securitised private investments. Our main alternative asset classes are private debt, venture debt, and recurring revenue financing. Kilde has partnered with leading non-banking consumer & SME lending firms to give investors safe and controlled access to consumer lending assets. Our unfair advantage is vast accumulated data on consumer & SME assets performance as well as scalable investment and securitisation tech platform. Thanks to Kilde’s license for dealing in securities, we securitize alternative investments into digital securities.

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Aleksandra Yurchenko

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