Custodians and third-party administrators increasingly are outsourcing valuation functions for private credit as the surge of institutional investor interest in the strategies raises concerns.
“All administrators have some capabilities in these assets, but only on very vanilla loans,” said Matthew Appel, managing director at private credit administrator Oak Branch Advisors, New York. “They can't service bespoke loans or asset-backed loans. Such loans are “very hard to model.”
Added Peter Sanchez, Chicago-based CEO of hedge fund services at Northern Trust Corp., “It's much more expensive to value private credit” because of the illiquid nature of the asset class, “making outsourcing of valuation more attractive.”
That outsourcing has benefited firms like Cortland Capital Markets Services LLC, Virtus Partners LLC and Oak Branch, which offer dedicated private debt administration. And while there's no industry tally of how much in private debt administration is outsourced, it's clear that with more institutional assets moving into private credit, there are more assets to be outsourced to specialized administrators.
An analysis by Pensions & Investments of hiring activity showed new assets committed to alternative credit strategies by institutional investors at $79.7 billion in the seven years and one quarter ended March 31. Commitments totaled $18.26 billion in 2016, up 348% from the $4.08 billion in 2010. Institutional commitments to distressed debt, special situations, mezzanine, structured credit and multiasset credit strategies hit a high of $18.3 billion in calendar year 2016, and the $7.4 billion in total committed assets in the quarter ended March 31 is the highest three-month total since the fourth quarter of 2009.
But along with more inflows into private credit come concerns about how those assets are valued. In Preqin's 2017 institutional investor survey on private credit, 62% expected to increase their investments in private debt in the long term, but 40% believed the difficulty in private credit valuations was a key issue facing the asset class in 2017.
It's that concern that has led some of the largest asset-servicing firms to outsource much of the valuation work, said Chad Burhance, New York-based CEO at Oak Branch, which was spun out May 22 from financial and risk management service provider NewOak Capital LLC, New York, in a management and employee buyout. Terms were not disclosed.
Before Oak Branch — previously known as NewOak Credit Services — began providing private credit administration services 18 months ago, “we got requests from third-party administrators to value illiquid loans,” Mr. Burhance said. “We found that a large swath of this was being done outside of traditional banking providers, and we got wind of that through private equity funds. When there are loan funds out there with 27,000 consumer loans and 5,000 residential mortgages, that's different from traditional private debt.”
At the time, NewOak surveyed custodians and large administrators “and found not one service provider had the capability to handle this,” Mr. Burhance said. “The rapid growth of the credit market caught administrators off guard.” Mr. Burhance said Oak Branch had seen a 100% increase in assets under administration in private credit in the past 12 months. He would not provide a figure.