As covid-19 ravages economies across the world many firms will become distressed, both within and outside of private debt portfolios. Being able to handle these distressed situations effectively will be what determines who come out the other side of this crisis with a strong track record and satisfied investors.
See all Private Debt Investor’s coverage of covid-19 and its impact.
The first concern for many fund managers is companies in existing portfolios that are suffering liquidity issues as a result of the pandemic.
Cedric Henley, partner in Solar Capital Partners’ commercial finance business, said: “On a day-to-day basis we’ve been focused on managing our portfolio of existing names. It’s important we understand their liquidity profiles and ability to weather the viral infection crisis.
“Some of our borrowers are applying for government support programs to keep them going while the shutdowns persist, we continue to engage with them as we monitor the portfolio.”
The coronavirus shutdown is likely to be one of the first major tests of much of the loan documentation used by alternative lenders, especially covenant-lite loans which have become a major feature of the market in recent years, according to Treabhor Mac Eochaidh, head of debt services at MUFG Investor Services.
“For many direct lenders, this is the first time these documents have been tested to see how well they protect them,” he said.
“The speed at which this downturn is unfolding probably means that covenant-lite loans will trigger quicker than expected. Lenders on these loans will be able to look at the price of the collateral which will have dropped considerably and use that to trigger.”
The speed at which covid-19 shutdowns have been implemented by governments across the world, and uncertainty about how long they will last, is one of the biggest factors putting stress on both portfolio companies and fund managers. Ted Goldthorpe, head of BC Partners Credit, said even banks will find it difficult to cope with the scale of the problem.
“The big banks are really well capitalised and have a lot of liquidity but they might struggle when it comes to handling defaults,” he said. “The sheer number of defaults means credit departments are already overwhelmed. This is worse than 2008 as it’s all unfolded in just a few weeks whereas the GFC [global financial crisis] took 18 months.”
While fund managers typically have smaller and more concentrated portfolios than banks, they also have smaller teams. Those without internal resources that have experience dealing with companies in distress may struggle.
“The challenge that some lenders may soon face is dealing with a lot of restructurings all at once,” said Henley.
Early signs in the market indicate constructive dialogues are already beginning between sponsors and their lenders to determine the best course of action for portfolio companies struggling with liquidity issues.
Goldthorpe added: “Mid-market direct lenders have not been rolling over to help the sponsors. There’s a constructive dialogue going on but sponsors are going to have to be realistic in their expectations of getting more support from their lenders.”
However, the distress and dislocation being experienced across world markets could also provide a major opportunity for alternative lenders in both the distressed and direct lending space.
Solar Capital reports that it has already entered into discussion with companies that it would not typically lend to.
“We’re talking to companies that we would not usually as they normally can go to the bank and get a loan for 200 bps above LIBOR but now they’re coming to us for structured solutions,” said Henley.
Mac Eochaidh said many firms are already getting prepared to meet the upswing in markets and deploy capital to where it will be needed as coronavirus restrictions come to an end.
“Managers are going to be focused on being opportunistic. They’ll be looking at how they can best handle opportunities coming down the road, looking at which companies are breaching covenants, but it’s going to take a while before loans become distressed.”
There is expected to be a lag before distressed situations come to market. As the crisis erupted in mid-March, first-quarter earnings may not be severely impacted and it is second-quarter earnings which could be the trigger that causes many firms to start seeking specialist turnaround help. In the short term, significant payment defaults are expected as firms wait to claim any government support packages they can.
BC Partners has already been active in buying loans on the secondary market but expects origination opportunities to grow as well as the crisis unfolds.
“On the secondary-side of the business we’re seeing a lot of dislocation and have used the opportunity to buy loans in defensive sectors like software or insurance. On the origination side we’re finding a lot of new opportunities as a lot of companies are in need of liquidity,” explained Goldthorpe.
“We have spent some time looking at some of the directly impacted industries and think there will be an opportunity to buy there eventually.”