A Holistic Approach to Credit in A Post-COVID Landscape
By: Kristin Castellanos and Ben Griffiths
Back in March, the COVID-19 pandemic began its rapid spread around the globe, triggering economies to shut down and credit markets to seize up along with virtually every other aspect of life as we know it. The situation has been so unprecedented and the disruptions so incalculable, that it’s difficult to say which of our new ways of living and working we will abandon as the threat subsides, and which are here to stay.
With credit markets beginning to stabilize and interest rates at historically low levels, the relationship between lenders and borrowers appears to have been permanently altered by COVID-19. An analysis of the lending landscape as it emerges from the economic crisis caused by the pandemic reveals new dynamics and a dramatic shifting balance of trade between the two parties.
Where once the onus was on banks to demonstrate a strong partnership to clients, eagerly competing for business and advancing credit on a pure yield basis, post-COVID liquidity constraints and other factors have dramatically changed that dynamic; now it’s the client who must demonstrate a willingness to work with the bank across a variety of products and services in order to utilize their in-demand balance sheet. This represents a very real change in the industry and a shift in balance in what we call “Relationship Borrowing.”
In Relationship Borrowing, clients need to demonstrate an appetite to grow along with the bank on a more holistic, long term level than previously imagined, with financing serving as only one aspect of a multifaceted partnership. With this shift, banks have become candid in their calls for clients to utilize additional fee-based services. No longer content to provide financing in exchange for the vague possibility of future revenue, banks are pushing heavily for specifics: financing in conjunction with bank accounts, foreign exchange services, third party administration, asset servicing and more.
With several large banks retrenching while investment managers expand their global investor base and seek increased financing to capitalize on the recent market disruption, there is opportunity for banks with asset servicing affiliates to fill the void.
Consider, for example, a U.S. manager of an Irish domiciled fund that is looking to attract investors in five different currencies. To successfully operate this fund, the manager must utilize a fairly complex fund structure in Europe (to both attract investors and be nimble for additional investment vehicles), create non-base currency classes, manage FX exposure, ensure local jurisdictional requirements are met and adopt a U.S. time zone friendly service model. With the overlay of fund financing requirements in a tight credit market, the Relationship Borrowing approach allows the manager to show themselves as an attractive long term partner to a full service bank; by utilizing multiple connected services to meet their operating needs they are also in the position to avail of fund financing.
Pre-COVID, fund financing might have been the entire conversation; now, it’s one side of the ledger, extended in conjunction with servicing the full range of the client’s various needs. A provider can still be tapped for financing, but fund managers can expect to have meaningful conversations on providing administration, depositary, custody and FX overlay execution and other related asset servicing. Even if only by effect, the sheer volume of such an engagement creates by its very nature a true partnership, one built for the long term and holistic in its scope.
The bottom line is that it’s easier to secure balance sheet allocation if you’re able to offer a holistic engagement. Managers are in the position to access more of a lender’s balance sheet if they look to broaden the relationship by engaging more non-balance sheet items for servicing. Like any good partnership, Relationship Borrowing is rewarding for both parties.
As fund managers look to secure credit from fewer sources, it will be interesting to see whether history repeats itself – during the rapid growth phase of the hedge fund industry, many prime brokers offered financing to hedge funds in conjunction with administration and other transaction banking services. For years, there has been speculation that the private equity industry will eventually fully adopt a third-party administration model; will the rapid growth of this sector combined with increased financing appetite be the catalyst that finally makes this a reality?
As demand grows for access to a large and stable balance sheets, bankers are being asked to defend every transaction. In this environment, clients will have to compete to demonstrate that they bring more to the table than yield-based revenue going forward. The best way to set themselves apart is by reflecting on how they can best contribute to the relationship between lender and borrower.
Managing Director – Fund Financing
Managing Director – Global Head of Fund Financing