More than 350 delegates attended the opening day of the PDI New York Forum. From our notes of what happened on stage and informal conversations around the fringes, we bring you some of the key insights and observations.
1. It’s feeling like Groundhog Day given that the end of the credit cycle has been a topic of conversation for so long. The focus is on making sure the downside gets underwritten as much as the upside.
2. The fundamentals remain pretty strong. Debt service coverage ratios are solid and companies are performing well. Having become rather weak in 2016, the fundamentals were given a boost by fiscal stimulus which has pushed further out the likelihood of recession.
3. Nonetheless, there is the potential for liquidity shocks, which could bring the cycle abruptly to a halt. Limited partners’ attitude appears to be that they are in no hurry for money to be put to work in this environment other than in selected areas of opportunity.
4. Specific worries revolve around high yield spreads and the lack of quality in underwriting. Limited partners are calling for a back to basics approach to underwriting and are very keen to understand exactly how managers are going about the underwriting process. Other worries include the increasing prevalence of adjusted EBITDA and what unitranche recovery rates will look like when there’s an increase in defaults.
5. Fear of not being able to meet target returns is driving some investors towards riskier strategies including special situations. A poll question found special situations to be the most favoured strategy of investors in the room – ahead of direct lending.
6. Leverage is a worry, especially fund level leverage. “Banks are not looking to lend aggressively to companies but they are lending very aggressively to funds,” said one LP, claiming to be very concerned by that behaviour. On the asset side, private debt investment should prove resilient to downside scenarios. But what about on the liability side? Has there been too great an acceptance of levered vehicles?
7. Pressure on managers to put capital to work quickly – partly because of fees being paid on invested capital only – has led to talk of “diligence-lite” scenarios where commitments are made based on just 3-5 days of due diligence. LPs are telling their managers not to rush.
8. LPs are calling for more creativity around fees, especially for the benefit of those investors able to commit large tickets.
9. Investors are focusing on the “how” in terms of existing and planned investments. They want to go into the minutiae of manager processes when it comes to origination and execution. Managers had better have the patience to explain.
10. Not enough attention is being given to the possibility that interest rates may rise quickly rather than gradually, and the market may not be able to adjust in time. Companies needing to access capital could suddenly find themselves unable to do so and end up in default.