The buzzword doing the rounds in private debt these days is “dislocation”. Fund managers are trying to kickstart a largely dormant fundraising market by persuading limited partners of their ability to transform into expert stock pickers as attention shifts from illiquid and long term to liquid and short term.
Not everyone is convinced. “If you’re talking about something that’s dislocated, it implies at some point it will be relocated,” drily noted one market source, who believed the trend would have only a brief shelf life.
Some think there are more sustainable opportunities out there, particularly when it comes to meeting the financing needs of companies with cashflow problems. While the global financial crisis was a liquidity event, market sources see the current crisis as more of a cashflow/solvency event. In the GFC, distressed opportunities emerged in the form of portfolios of non-performing loans being offloaded by the banks as they came under unprecedented balance sheet and regulatory pressures.
Today, the banks are generally on a more solid footing and opportunities are less likely to come from bank stress than from companies facing cashflow issues – many of which leveraged themselves up in the good times in the expectation of being able to refinance cheaply. For many of these businesses, leverage levels are now looking unsustainable and refinancing impossible.
There is a feeling that, as a result of this, the opportunity in the distressed space has shifted from restructuring to lending. Recent years have seen the banks retrenching from lending to smaller businesses. In the period ahead, many fund managers that have taken a lax approach to deal structuring may find themselves in the same boat. A new lending gap has opened for those willing to lend to complex and stressed situations. Fundraisings from the likes of Signal Capital Partners and Arena Investors appear to be indicative of this.
One characteristic of the new fundraising pioneers is their focus on asset backing. This is seen as an important way of safeguarding value at a time when the future of whole industries – never mind individual businesses – is so hard to predict. Unsurprisingly, the use of covenants is also back in fashion. The implications of the covenant-lite era may take a while to be fully revealed, but it seems very unlikely that any of today’s new deals will be constructed along similar lines.
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