How to co-operate your way through a crisis

Our annual conference in New York (virtual of course) lifted the lid on how participants in the direct lending market are faring in a changed landscape.

This week, we’ve been bringing the asset class together through our virtual New York Forum 2020. Here are some observations we heard from those involved in the direct lending market:

Collaboration has surprised on the upside: The usual caveats about vested interests may apply here, but the view was loud and clear that sponsors and lenders have generally been rubbing along well during the crisis (so far at least). Sponsors have been providing capital infusions for portfolio companies, assisting with operational aspects and taking cost out where necessary. “Everyone has worked together constructively,” said one panellist. Both lenders and sponsors appear to be resigned to, on average, longer hold periods.

The approach to deal opportunities is open-minded: One exec at a largely US-focused GP said his firm had headed to New Zealand to do a deal, a “good credit risk-adjusted” transaction in a country viewed as having dealt well with the virus. On the whole, a panellist said, deals are “a bit more off-the-run and bespoke” but certain businesses, especially those that have embraced digital adoption, are still capable of delivering 8-12 percent returns. Life science is popular (either not correlated to covid-19 or possibly even helped by it), while contrarian investors are eyeing dislocation opportunities in energy.

Dealflow is picking up: Panellists noted a pick-up in M&A activity over the last few weeks, some of it growth opportunities and some restructuring. A lot of incremental facilities are being put together to allow portfolio companies to fund acquisitions and roll-ups, and some of these have been priced fairly aggressively. In the secondary market there was a window in the spring but opportunities remain as “some credits are still trading lower than they need to be”, according to one observation.

There’s a strong level of competition: The message was that there are still plenty of lenders out there in decent health. While there has been some consolidation of sub-scale business development companies, the industry has not witnessed the wipe-out some predicted in the immediate aftermath of the viral outbreak. For some deals, competition is now considered to be significant and exacerbated by lenders gravitating to a smaller number of favoured sectors.

Other observations: Lower interest rates may not have the impact on returns some imagine given the incorporation of LIBOR floors into many deals; while there hasn’t been much consolidation so far, it is likely to pick up over time; venture debt has momentum, with strong demand from growth companies for non-dilutive capital.

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