As the long benign environment for private debt investing appears to have come to an end, we ask industry players for their thoughts on the ups and downs of the current situation.
You can find all Private Debt Investor’s coverage of coronavirus and its impact here.
John Bohill, partner, StepStone
Biggest challenge: The unprecedented sell-off has impacted the private debt arena in a manner which will not be fully realised for some time. Borrower and portfolio level exposure to the double-whammy supply and demand shocks caused by the public health emergency will play through valuations over the coming quarters, while liquidity crises are somehow dealt with. However, we are very clear – this is not a time to be risk-off, but to be risk-conscious, sober and disciplined. The banking and financial system is perhaps more prepared and sophisticated, since the expensive education of GFC. There is also significant dry powder.
Biggest opportunity: In terms of opportunities arising, we divide these into two phases; near-term dislocation and medium-term recovery. In the first phase, we see forced sellers creating new attachment points for informed investors (using sensitivities developed in the last correction). This definition extends to syndicated loans, senior CLO paper and BDC equity. We also see opportunity in providing liquidity to the entire space on a primary basis. Into the second phase, rebalancing of portfolios will enable us to deploy more capital into portfolio secondaries, supporting GPs and LPs with liquidity and business continuity. We also see medium-term opportunities in subordinated CLO. And finally, as the capital markets reorganise, we remain committed to primary direct lending, perhaps with favourable yields, and better credit discipline. Key to unlocking all of the above is maintaining constant dialogue with our managers and investors, such that opportunities may be understood, evaluated and executed in a timely and considered fashion.
Nick Rees, chief executive officer, Blu Family Office
Biggest challenge: We are living in truly unprecedented times. Financial markets have been hammered during March, and credit spreads have blown out across the board. With regards to short-term private credit, though, it is too early to assess the true impact of covid-19 as we have never been part of the social ‘lockdown’ experiment now being undertaken across the globe. Some ramifications are clear – the travel, retail and leisure sectors are already on their knees. Generous government support is being offered to corporations and individuals alike but the medium-term consequences for sovereign debt levels are dire. Inflation is in the pipeline.
Biggest opportunity: Trade is still flowing globally (for now) and, indeed, China is already ramping back up. In the short term, returns from short-term private debt deals are seemingly unaffected with positive performance being posted in February and March. What is less clear is whether defaults will rise meaningfully, or whether any of the private debt funds are seeing large redemptions as investors seek liquidity wherever they can. Where there are no big liquidity mismatches between investors and underlying loan terms, private debt funds should be well positioned. The length and depth of any global contraction will determine how much pain, if any, this sector will experience.
Daniel Roddick, founder, Ely Place Partners
Biggest challenge: For many GPs in Europe it will be the first real challenge of this sort. Most will be affected but it will have a disproportionate effect on those with exposed industries – food/beverage, hospitality, entertainment, tourism, etc. LPs will look back at this period and judge the GPs on how they fared, but not necessarily fairly – many will look at the outcome rather than the story that got them there. GPs will need to demonstrate their workout skills, but it will also be a test of their deal structuring and portfolio construction. It will also test the strength of the GPs’ risk management controls and operations. Finally, there is also the human aspect. Firms will face a fine line between managing cashflow while being sympathetic to staff, portfolio companies’ employees and the impact on their families. I believe they will ultimately be judged on both.
Biggest opportunity: The biggest opportunity will be for GPs who can adapt to the environment and provide essential financing for firms in need. Ultimately, perhaps the greatest opportunity will be in distressed debt, but in the meantime, companies will need financing to continue to operate. Funds that continue to lend to sound, strong businesses may be able to negotiate higher spreads. Those who can be versatile, who are not afraid to invest through the cycle and provide support without being exploitative will fare well. There will also be an opportunity for LPs and secondary firms to provide near-term financing for GPs and their portfolios. We are already speaking to both GPs and LPs on this and expect to see a lot more of it.