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Credit markets have changed profoundly since the 2008 fiscal crisis, with broadly syndicated loans (BSLs) and private credit replacing bank lending as primary sources of debt for corporate and private equity.

As banks tapped down lending activity in the aftermath of the 2008 credit crunch to focus on repairing balance sheets, BSL markets and successively private credit managers stepped in to fill the gap and have not looked back.

According to Preqin figures private debt assets under management (AUM) have increased more than four-fold during the last decade, and currently sit at approximately US$1.6 trillion. Leveraged loan markets in the US and Europe, meanwhile, have seen loan issuance more than double since 2015 to exceed US$1 trillion in the first half of 2024, according to figures compiled by law firm White & Case.

As private credit and BSL markets have grown, so has competition, and to differentiate their propositions, lenders and private credit investors have adopted more sophisticated and complex credit strategies.

Previously private credit and BSL would focus on servicing different borrower groups, but as strategies have evolved, head-to-head competition for the same deal opportunities has intensified. Pitchbook figures, for example, show that US companies refinanced more than US$13 billion of private debt in the BSL market during the first four months of 2024, a 180-degree flip from the second half of 2023, when most borrowers were refinancing BSL borrowings with private debt.

Market evolution drives middle office transformation

As competition across credit markets has ramped up, lenders have had to reappraise their middle office operational and technology infrastructure and ensure that the administration of the individual credits in their portfolios is efficient, accurate, and as frictionless as possible for borrowers and other key stakeholders.

In a crowded market, where borrowers have a wide pool of lenders to choose from, a reputation for best-in-class middle office service – including tasks such as loan accounting, loan agency, trade settlements, interest rate payments, borrower and lender communications and borrowing bases – can serve as a point of differentiation for companies and sponsors when selecting a credit partner.

The last 24 months of dislocation across credit markets have served to further emphasize just how valuable and important middle office capability has become for credit managers.

As interest rates have climbed, so have the costs of floating rate debt structures, which have added to the workloads of credit middle offices, which have in turn had to keep track of agency notices, rate resets and margin changes. Covenant compliance and loan amendment negotiations have also increased in volume as financing costs have climbed, directing further demands into middle office in-trays.

Managers and lenders that had been able to get through with lean middle office operations in bull-markets have had to reengineer middle office operations to keep up with the higher volumes of increasingly complex and important loan administration workloads.

Middle office support

Instead of hiring in much larger middle office teams and locking up cash in capital expenditure to keep pace with rising middle office workloads, credit providers can take advantage of the technical and technological expertise of an outsourcing partner to put in place a middle office model that is flexible and scalable.

Alter Domus, for example, has supported credit provider clients with comprehensive loan servicing and monitoring support for more than two decades, and has built up the specialized expertise and technology stack to cover the ever-intensifying technological and operational asks of middle-office credit teams.

All aspects of loan servicing needs can be handled by Alter Domus across our middle office service offerings:

Our Loan Agency offerings via our Agency Services team allows us to serve in a variety of agency roles including named administrative agent, sub agent, successor agent, and more. In doing so, our teams handle jobs including counterparty communication, oversight of covenant compliance, and agency notices.

Our Loan Services offerings provide an array of coverage including loan accounting, loan servicing, trade settlements, and CLO services. Our teams are perfectly positioned to take care of complex, time-consuming day-to-day workflows that are essential to the life of a loan.

Our Loan Monitoring solutions provide digitized, normalized financial information from borrowers delivered to your monitoring solution of choice or our modern portal.

Our middle office servicing relies heavily on our proprietary administration platforms CorTrade, Agency360, Solvas, and VBO to support clients across a broad suite of accounting, modelling, and credit risk solutions. Alter Domus’ tech platform covers all these tasks, and others, with an interface that can operate within a client’s portfolio management system and process a wide range of reporting, data, and internal accounting functions.

When reviewing middle office infrastructure capability, it is also crucial for managers to ensure that the middle office links in to both the front and back office, and that teams in these three functions are not operating in siloes.

Each team will often use different systems, technology platforms and servicing teams to execute their core functions, but it is important that all functions are integrated, and that there is a secure, accurate data trail that can be traced from the beginning to the end of the loan lifecycle.

Our firm has leveraged our credit and technology expertise to help several credit providers build data bridges between the technology and software used in separate functions, and integrate data from preferred front-office, middle-office, and back-office platforms to ensure data veracity.

Working with a partner like Alter Domus enables credit providers to focus on their core business of originating opportunities, assessing risk, and underwriting new financings, confident in the knowledge that they have the middle office support in place to manage loan servicing tasks to the highest industry standards.

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In what has been a challenging period for alternative investment managers, the private debt asset class has been a standout performer.

According to McKinsey, private debt generated stronger returns than all other private market asset classes in 2023 and was the most resilient for fundraising.

Rising interest rates benefited private debt firms, due to the floating rate structures that gains when base rates climb. This has driven ongoing investor demand for the strategy, proving its ability to deliver attractive risk-adjusted returns across the investment cycle.

The robust performance of private debt strategies through the recent period of market dislocation and uncertainty follows a period of remarkable growth for the asset class.

Private debt assets under management (AUM) have more than quadrupled during the last decade, according to Preqin figures, and currently stand at approximately US$1.6 trillion. And according to BlackRock, the private debt industry is well-positioned to sustain its growth trajectory. AUM forecast is set to reach US$3.5 trillion by the end of 2028 as borrowers continue to favor the bespoke and flexible financing structures offered by private debt managers, and investors, many of which are under-allocated to private debt, move to grow their exposure to the asset class.

Preparing for the next cycle of expansion

For private debt managers, the rapid increase in industry AUM has brought their franchises to an organizational tipping point.

Private debt firms are not only managing larger pools of capital for a more diverse, demanding investor base, but are also executing increasingly complex investment strategies that have expanded beyond bilateral, middle-market loans into big-ticket club deals and opportunistic purchases of debt tranches.

Unlocking capital from a global investor base and expanding deal pipelines into new areas have opened exciting opportunities for managers. However, capitalizing on these prospects will require private debt firms to upgrade their operational infrastructure to sustain their growth.

Managers have not only had to enhance their back-office fund accounting and investor reporting functions to serve an increasingly demanding and sophisticated investor base, but also their middle-office loan servicing and loan administration services to borrowers and the companies to which they lend.

The lean operations that supported private debt through its first phase of expansion will have to be upscaled to ensure that managers can maintain operational nimbleness, and the ability to measure performance while tracking risk, as transaction volumes rise.

Increasing middle and back-office capabilities do pose operational challenges for managers. Staff and technology costs ramp up, while the impacts of additional processes, sign-offs and internal bureaucracy can compromise the agility and responsiveness that have underpinned previous success and growth.

It has also become crucial for managers to establish seamless links between front-office dealmakers, middle-office, and client-facing teams that support borrowers, and back-office teams managing fund accounting and reporting.

Key areas for consideration

As private debt managers enter the next phase of the asset class’s evolution, there are three key questions that should be asked before embarking on an operational overhaul:

Does integration exist through the front, middle, and back office?

While the oversight and investment management of a private debt fund does have similarities with other alternative asset classes such as private equity and real assets, there are specific deal structuring and fund accounting requirements that are unique to private debt.

Loan structures, for example, will include multiple tranches, varying rates and payments of principals and interest. Managers must also be able to source and analyze data in markets where public information is less available than in syndicated loan and bond markets.

The fund accounting required to track and report on private credit portfolios and investments is also vastly different from what is required in private equity portfolios, for example.

As managers expand, it is essential that their accounting and operating teams have the requisite experience to handle the specific demands of private debt fund accounting and reporting.

It is equally important for private debt managers to have the middle-office capabilities to take loan agency responsibilities, such as for individual investments, handle all trade settlements and interest rate payments, and to administer borrowing bases.

Outsourcing or in-house?

Managers must decide if it is best to outsource both back- and middle-office functions as their operations grow or invest in building additional infrastructure in-house.

Keeping operations in-house gives managers direct control of loan operations, fund accounting, and data, which has its advantages, but does come with high upfront costs and makes it more difficult to scale up back-office resources in the future.

Outsourcing to a third-party provider allows managers to benefit from the global reach and extensive industry expertise of fund administration specialists. It is also important to factor in that when a manager ramps up the size of internal teams, the GP bears those costs. In contrast, when outsourcing, the costs of administration are covered by the fund.

If managers do choose to go down the outsourcing route, it is crucial to have clarity on what infrastructure and technology will have to be retained internally to oversee, engage, and interact with a third-party fund administrator.

Managers must also be clear on the scope of work that a loan servicer and fund administrator can handle. Not all partner firms, for example, can deliver portfolio accounting via their loan administration systems.
Managers should be clear on exactly what support they require and whether the administrator can meet that request.

How will data challenges be addressed?

Data management poses distinctive challenges in a private debt context, as different teams within a firm have different technology and data requirements.

Investor relations teams, for example, want to access performance data to report to LPs, while operations teams prioritize the data requirements of investment professionals and fund accountants want to ensure that books are up to date.

This has seen the asset class move away from single systems, which aim to cover the full loan cycle and serve as a “single source of truth,” to a model where there is an interlinking patchwork of technology platforms and servicing teams.

As data linkages between different operations and teams grow in importance, the middle and back office must become more fluid and integrated.

Ensuring that the data linkages between these teams and their respective technology tools are fully integrated and seamless is complex and impacts how back-office and mid-office functions are structured.

Whether outsourcing or keeping operations in-house, firms must ensure that operating models are structured in a way that aligns the back office and middle office teams and helps to facilitate the “front-to-back” integration required to support multiple complex front office investment management tasks.

Curating an operating infrastructure that covers these priorities and meets the specific demands of each individual private debt manager lays a firm foundation for building a scalable operational model that can grow with a private debt platform.

The value of a supportive loan servicing and fund administration partner

Transforming an operating model is demanding and can distract managers from their core front office investment management priorities.

Working with an experienced servicing partner and tech provider like Alter Domus, which has extensive asset class experience, a clear understanding of how private debt managers work, and insight into the key operational priorities they are seeking to address as their organizations grow, eases implementation and ensures that managers are putting the right structures in place.

We have the resources and expertise to help private debt managers take their operating models to the next level by streamlining processes and harnessing technology, and have supported clients’ operational requirements in the following ways:

Provision of a full suite of services

Alter Domus provides an end-to-end service to private debt managers that covers every operational requirement, including loan administration, portfolio accounting, loan agency, loan servicing, and fund administration, as well as full data integration across these functions.

Technology expertise

Alter Domus has successfully implemented proprietary technology to support all its services. Alter Domus’s Solvas platform, for example, integrates accounting, modelling, and credit risk solutions to serve as our proprietary loan administration system.

This means Alter Domus can integrate data and operate within a client’s portfolio management system, providing regular reporting and data feeds that allow clients to update their internal accounting systems.

Data integration

Alter Domus’s technology expertise means it can also support private debt managers with the design of technology stacks and operating models that support data integration.

We can help clients to connect the various preferred technology tools of their teams and facilitate the fluid movement of accurate data between different teams and across different technology platforms. This ensures that there is a golden copy of all data throughout the full loan and fund lifecycle.

Partnering with a firm like Alter Domus can help private debt managers to re-energize their focus on strategic growth and ensure that their support structures are agile and fit for purpose in a private debt asset class that continues to grow, develop, and become more competitive.

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Interview

Q Given the rapid growth of private credit, what do managers need to consider when shaping their operating models to take advantage of new opportunities?

There are a number of considerations – not only the outsource versus insource question, and which systems and technologies to engage, but also the allocation of costs. Typically, overheads and internal staff are paid for by the management team whereas fund expenses or middle office administrative costs are borne by the funds themselves. Attempting to reach that balance with the right oversight and the correct cost allocations is a challenge, as is how much control you want over the entire system. Oversight and control can take many forms, managers need to ask themselves whether it is enough to have a small staff overseeing a provider, or whether building an entire oversight operation that oversees everything done by a provider would serve their interests better. Similarly, private credit has far more moving parts than exists in bonds or equities. Obviously, the oversight and investment management is similar, but loans are more complex with multiple tranches, different rates and payments of principal and various sources of income that need to be tracked. Added to that, the information ecosystem that exists for broadly syndicated loans isn’t there for private credit, so you may be in a small group of lenders where the data is not easily recovered, creating its own problems.

The choice of operating model also depends on the size of the manager and their level of experience. The infrastructure required for private credit operations and accounting is very different to private equity. In credit, you need the ability to track portfolios that are very dynamic – an entirely different skillset for accounting and operations staff . Investors now typically require a fund administrator, so the question really is what level of infrastructure is needed to engage and oversee your chosen administrator. At Alter Domus, we use a number of systems. We own innovative technology such as Solvas, which offers integrated accounting, modelling and credit risk solutions, alongside a licensed loan administration platform called Sentry. This means we can support from inside a client’s own portfolio management system – integrating data and sometimes even operating from within the client’s systems. All these options feed into our fund accounting systems, which provide managers and investors with regular reports – either on a monthly or quarterly basis. Clients receive data feeds so they can update their own internal accounting systems. Some clients are very light touch and comfortable with an outsourcing model; others run a full internal operations team that tracks what we are doing daily. There is a cost implication to the latter, but we work to what our clients need.

Q What should managers look at when considering outsourcing versus insourcing options?

Not all fund administrators offer portfolio accounting in their loan administration system, but at Alter Domus, we find that it is key to the core team having enough understanding to be able to check daily. Whether you opt to outsource or run your own team, experience is key, something which we have found is getting harder to find amid the talent squeeze that exists within running private credit operations. Finally, I’d highlight the value in an organization’s ability to manage and track data internally and whether they have the requisite software and IT systems that can support substantial data.

Q How can managers maximize opportunities around technology to support their operations?

We have found that a lot more managers opt for co-sourcing arrangements today, meaning we do the work on their systems. They can trust that they have full transparency and access to everything we do, as well as the ability to seamlessly access the underlying data that we work with. This is becoming the preferred model and more commonplace, as managers can achieve greater efficiencies when they don’t have to manage or hire staff – they are making the investment in the technology but not the headcount.

We have completed several successful lift-outs over the past few years when we took on the staff and cost from a client and updated their systems. In doing this, we construct a revenue model that makes sense for the manager, while giving their people a career path that they might not have access to if they stayed at the fund manager. It is much more important to investor today that they have access, through their manager, to all their underlying portfolio data, so it often makes sense for managers to own that IT infrastructure.

Q What should GPs prioritize for data integration?

Within each GP, there is often a struggle between constituencies. Investor relations teams want a whole set of data around performance and what they can put together for investors; operations teams need enough access and availability to analyze data and satisfy investment professionals; the front office wants feedback on performance of the portfolio assets, and the accounting team need to make sure the fund books and internal books of the manager are up to date. There is no single system that does all those things and satisfying all of those constituencies is huge task. Many of our clients will focus on one aspect first before moving forward with others, depending on their own priorities.

Q How are both LP and regulatory demands likely to evolve going forward, and what can managers do to future-proof their approaches?

It is always risky to speculate on this, particularly in the US, given the political backdrop of a presidential election year. What is clear is that there will be an even greater increase in regulation and oversight down the line, as legacy private credit was historically handled by regulated banks and institutions. Despite the overruling of the SEC regulations, we expect an increase in adoption of the practices and disclosures recommended in them, as well as a heightened focus on how private credit operates with investor money being lent to private companies. Understandably, LPs want more and more. The operational data that we help clients prepare for the more sophisticated LPs is increasingly time-consuming, with requirements for everything from information safeguards through to physical office security. The detail required in these requests is also getting more and more granular. Managers need to have a highly robust framework in place to ensure their internal infrastructure can meet those demands. That means thorough change management investment underwriting and oversight processes, and partnering with service providers that have corresponding policies and procedures. Even more investment is going to be needed into compliance infrastructure, or in partnering with others that have made that investment in a way that can be relied upon.