Credit Funds, an alternative for Banks?

January 16, 2024 Nicolas Van Klinkenberg

Key take-aways from this article in De Tijd by Kris van Hamme are that credit funds have grown strongly and are becoming serious alternative to banking loans. Most of these funds are Headquartered in the London or Paris, only a few have offices in Brussels or Amsterdam. Now that the sector has reached a systemically important size, with the largest of these funds reaching 30 – 40 bn +, question is how the increasing interest rate affects the clients of those funds and impacts the default rate in the credit funds loan portfolios.

Institutional investors (e.g. insurers, pension funds) are heavily invested in credit funds, as Limited Partners (LP’s). How would a default in the portfolio of a credit fund have repercussions on these institutional investors and how would the clients of the institutional investors, who trusted their savings to those institutionals, react to that?

To cut it short: Could a (series of) default of a debt fund lead to a fall in confidence in the sector? Or otherwise said: could it affect the an insurers’ liquidity or solvency?

1/ First of all, institutional investors like insurers have very solid liquidity and solvency ratios to follow and are strongly regulated. Their investments in credit funds are sizable in money, but done within a set of investment policies, checks and balances.

2/ Secondly, even though a credit fund is not a bank and is not regulated as a bank, still their lending policies are also based on prudent lending. Credit funds typically select 2 to 4 files out of 100 they receive and have strict guidelines on diversification and financial ratios of their loan portfolio. A comparison with private equity parties is by nature wrong because the exit strategy of both is totally different. A credit fund will assess a financing to be provided on the basis of the pay-back capacity of a client, while a private equity fund will base its exit on commercial development of the target company.

Getting back to the article, the few Belgian experts interviewed are right in that in the local Belgian market credit funds have a very limited presence and that even if there would be one of more defaults in the portfolio of a local European credit fund, this is far from leading to a systematic crisis. This is mainly due to the fact that credit funds are typically way better capitalized than a bank traditionally is. Remember that a bank has an equity-to-loan ratio of 3 to 6%, credit funds are fully funded by their LP’s. This means more capital is present to counter potential losses on the portfolio.

In addition, the rise of credit funds in recent years is a rather positive evolution from a macro-economic perspective, according to J. Groothaert (Director Fiduciam). Since it means that more capital is provided for loans that carry a certain amount of risk banks are not willing to cover.

More interesting for the regular readers of the Ernest Partners posts:

Would you be interested in getting in touch with a credit fund? Do you believe that a credit fund could be a good alternative to the traditional banks for your company?

Get in touch with us, At Ernest Partners we know the market of alternative finance and can make a comparison of bank loans vs credit funds. This to directly guide you to the right financing partner for your company.