As banks lose market share in traditional commercial lending, some are seizing the growing opportunity of providing short-term financing to private equity and venture capital funds, says Moody’s Investors Service.
With banks losing ground to private credit suppliers in traditional lending, they are increasingly finding business in capital call lending — which are effectively investment bridge loans for PE and VC funds, Moody’s said in a new report.
These loans, “enable fund managers to make investments with fast execution and support their cash management,” Moody’s said.
The collateral for these loans is the obligation of the funds’ limited partner investors — such as pension funds, sovereign wealth funds, family offices, other institutional investors, and high-net-worth individual investors — to supply capital to the funds, rather than underlying assets.
According to Moody’s, demand for this sort of lending is growing alongside the growth of PE and VC investing.
As a result, banks are increasing their lending in this area, and more banks are looking to get into the business, it said.
According to the report, the credit quality in this type of lending is typically very strong — but it also warned that increased competition in this space could result in growing risks too.
“Capital call lending has traditionally been well structured and has an extremely low loss history,” the report said.
“Even so, it requires expertise, good operational processes and a clear understanding of the credit and legal risks. And many banks have a very limited track record, so intensifying competition could undermine structural strengths and increase risk appetites,” it added.
Key underwriting considerations for these sorts of loans include the strength of the limited partners, the legal protections in the loan documentation, and the track record of the funds’ general partners, Moody’s noted.
Moreover, it pointed to possible risks from this activity — including the fact that the rarity of defaults in this area means that, “many of the legal protections provided in the loan structure and documentation are somewhat untested with respect to enforcement and recovery.”
Additionally, the low loss history from this sort of lending “could increase the risk of complacency,” it cautioned.