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John Rizzo, Paladyne Systems
John Rizzo, Paladyne Systems
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Bank Debt Deals Pose Operational Risk

Alternative investments firms are realizing they cannot manage an entire asset class in a non-systematic manner.

John Rizzo
One silver lining in the current economy is the number of interesting bank debt deals available. As an asset class, bank debt is growing in popularity because of its relatively low risk, in terms of its position on the cap structure, and high returns, particularly when compared with other asset classes; such as equities, bonds or derivatives. In the current economic environment, asset prices are low, prompting many alternative asset managers to buy into distressed debt and other opportunities.

Alternative investment firms and other non-traditional lenders – which are able to act quickly to invest in the credit markets – are playing an increasing role in returning liquidity to the corporate lending market. Investors looking for high returns with lower risk exposure are seeking out alternative asset managers who understand and can handle investments in this space. Even funds that have traditionally traded non-credit assets are looking at ways that they can improve by adding a credit strategy to their portfolios.

Alternative investment firms are participating in the primary market, originating deals and acting as the agent, as well as the secondary market, where they are actively trading bank debt. In both cases, managers have several operational challenges. Funds that are originating loans must have the capability to handle the work involved with being a primary lender, including the asset management and loan administration functions, which require considerable time and effort. Often this means monitoring the deal through numerous metrics, periodic due diligence, restructuring the deal and potentially having to deal with workout situations with the borrower when things don’t go right. Given the manual nature of this work, often funds will be forced to hire many people, with extensive experience and expertise, to perform these roles.

For funds participating in the secondary market, a significant operational consideration is how they will quickly settle and manage their positions to make sure the economics of their holdings are correct and that the agent properly reflects the funds position in the deal; for instance, funds have to process numerous updates from the agent and confirm that the agent has accurately administered the fund’s portion of the deal. Because bank debt dealings are largely manual – involving fax and email – firms must figure out a way to improve the efficiency of managing their positions, maintain transparent exposure reporting and decrease operational risk.

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