Loans have traditionally been the domain of commercial banks, but the financial crisis of 2008 made loans a riskier investment. New regulatory and reporting requirements emerged, making it more expensive for banks to offer loans to the private sector. As a result, banks began offering loans mostly to large public enterprises.
Meanwhile, small and medium-sized enterprises have continued to expand domestically and internationally. Private equity and private debt funds have gained popularity as these businesses have sought capital to achieve specific goals, such as launching new products and investing in research and development, real estate, and technology infrastructure.
The private debt market has grown steadily over the past two decades, rebounding after a dip during the height of the pandemic. Moving forward, private debt is expected to outpace private equity in terms of the total number of global assets under management.
Unlike banks, which have a dedicated staff for loans, firms that offer private debt loans aren’t necessarily equipped to handle the operational aspects of lending money. Third-party providers have entered the space to offer fund administration and loan services, especially as private debt loans grow in size and complexity. This article focuses on private debt loan services, in particular the roles played by loan agents and loan administrators.
A private debt loan scenario
In a typical scenario, a borrower (such as a business) approaches a fund manager (that is, the lender) to gauge interest in giving a loan. The fund manager and borrower agree on terms and conditions, say a $10 million loan at 10 percent interest. The fund manager’s firm then reviews the deal to ensure it meets its investment criteria.
At this point, the fund manager may decide to hire a third-party loan administrator.
Responsibilities of a loan administrator
Loan administration services broadly include loan settlements, cash reconciliations, compliance calculations, trades, trustee tie-outs and waterfall payments. Here is a list of specific services typically performed by a loan administrator:
- Maintaining an accurate, up-to-date database of a client’s loan portfolio.
- Calculating principal and interest on loans.
- Tracking payments made by borrowers to lenders.
- Analysing the loan portfolio and displaying the results on a dashboard.
- Consolidating information and distributing it to the fund administrator’s system.
The above services are relatively simple and straightforward. There is, however, another role in loan servicing that is more complex and involved — that of the loan agent.
Responsibilities of a loan agent
The role of the loan agent, and how it differs from that of the loan administrator, is perhaps not as widely understood as it should be, even by those within the private debt industry. Let’s take a look now at the kinds of services a loan agent provides. (Note that a fund manager does not have to hire a third-party loan agent to perform all of these services; he or she can choose some or all of them.)
- Calculating, preparing and distributing the rate-setting notifications of the loans.
- Running a waterfall of payments on each interest payment date.
- Preparing and executing cash payments (this is a critical point of differentiation between a loan agent and a loan administrator).
- Collecting the borrower’s financial-covenant testing results and other financial information on a timely basis.
- Distributing information to lenders in accordance with the loan agreement.
- Distributing information and facilitating communication between lenders and borrowers of all other ad-hoc information received from time to time.
- Appointing third-party professionals (such as valuers and lawyers) according to the instructions of the lender.
- Managing security agent responsibilities, including working with counsel to perfect a security package.
- Displaying a portfolio of investments on a loan analysis dashboard.
- Consolidating information and distributing it to the fund administrator’s platform. (In some cases, the loan agent and fund administrator may work for the same third-party services provider.)
Benefits of using a loan agent
As the above lists make clear, a loan agent’s role is more involved than a loan administrator’s. While both roles ensure the smooth flow of information, the more expansive role of the loan agent offers several benefits, including:
- The loan agent has no commercial or financial interest in the terms and conditions of the loan, which is especially significant when there is more than one lender, since complexities and conflicts increase as the number of parties increases.
- Cost savings. The loan agent is a third-party provider with investments in human capital, technology and other resources that typically make the cost per loan less expensive to administer.
- By outsourcing loan management, a lender doesn’t need to deploy resources in this area, allowing the lender to concentrate on other, more important aspects of their business, such as investor relations and sourcing new investments.
- Enforcement of loan terms. In the event the borrower does not meet the contract terms, the loan agent plays a crucial role in appointing receivers, coordinating actions with various parties and disseminating time-sensitive legal notices.
- Transfer of security interests. When a fund manager hires a loan agent, loan security (such as real estate of the borrower’s) is held in the loan agent’s name for the benefit of the lender. If the existing lender decides to sell its exposure to a new lender, and the latter keeps the same loan agent, there is no need to de-register and re-register the security package. This can save a lot of time, and more importantly, is more cost-efficient.
- Access to productivity-enhancing technology. Some loan agents work for services providers that offer technology with fewer limitations than banks’ legacy systems. Outsourced services providers often can centralise and digitise manual, paper-intensive processes. They are also likely keeping better pace with technological advances in optical character recognition and application programming interface integration with enterprise management and customer relationship management platforms. They typically can provide robust data analytics that are easily viewable on dashboards.
Not all services providers offer loan agent, loan administration and fund administration services. Furthermore, the technology offered by services providers varies considerably, because offering the latest platforms requires significant investment. Fund managers should research these factors, along with pricing, reputation, global footprint and other considerations, when vetting providers.
John Greaves, Manager, US tax at PDI, contributed to this article.
