Covid-19: Debt funds will cushion credit crunch for LBOs

Debt funds could provide a countercyclical source of credit during the crisis, but there are concerns about the impact of cov-lite.

The increased role of debt funds in financing leveraged buyouts should mean more capital is available to finance deals during the coronavirus pandemic than during the Global Financial Crisis more than a decade ago, according to analysts at PitchBook.

A note on the impact of covid-19 on private markets said that banks are likely to pull back from lending in a recessionary environment but private debt funds are sitting on $241.4 billion of dry powder as of Q2 2019. Due to the large amount of capital still available through private debt funds, PitchBook does not expect debt financing to dry up in the same manner it did in late 2008 and through 2009.

However, larger private equity deals remain heavily reliant on bank-arranged syndicated loans, which could mean those deals will be more difficult to get off the ground in a restricted credit environment.

Leveraged loan volumes have declined sharply since the crisis erupted with just $860 million of leveraged loans coming to market in February, down from $87 billion in January, a 99 percent decline.

PitchBook also said if the downturn becomes extended then it could be the first real test of the covenant-lite contracts that have become dominant in the LBO market in recent years.

“The recent surfeit of capital and proliferation of covenant-lite loans have left creditors with fewer protections and had already spurred concern that this sort of scenario would develop,” the note said.

It also signalled that the energy industry could face particular problems, saying: “Recent volatility in the energy markets could spur more bankruptcies in an industry that was already struggling to service its debt.”

The crisis could also spur opportunities for distressed debt and special situations investors, who are now well capitalised after high levels of fundraising in recent years and will be able to acquire assets at depressed prices.