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.
Cecile Mayer-Levi, head of private debt, Tikehau Capital
Biggest challenges: The sudden outbreak of the covid-19 pandemic has led to a major need for portfolio companies to preserve their underlying liquidity position. Therefore, as private debt lenders, we are receiving requests for a number of supportive measures to create some liquidity buffers for our portfolio companies, for example interest payment postponements or covenant breach waivers. Depending on the situation, we are usually supportive, playing our role as a stakeholder in these companies.
We are also receiving requests for additional indebtedness to allow state-guaranteed loans which are widely available to companies to help them face the abrupt halt in their activities. This additional state loan scheme is adding increased leverage into the economy, in particular for SMEs, and the majority of these state loans are unsecured which weakens loan-to-value ratios and reduces protection. While banks and crowdlending platforms are so far the only institutions entitled to grant these state loan schemes, which will act as a catalyst to “save” these weakened companies, private debt funds could also be a useful tank of skilled resource to distribute these programmes.
So far, there has not been any defaulting from our investors, but we expect that the economic and financial crisis will extend the holding period of our portfolio, which therefore could raise issues among investors. We are also receiving a significant volume of requests in terms of communicating information to LPs, specifically around our ability to provide cashflow projections in terms of return of cash, capital calls, as well as potential impact on distribution, in particular when impacted by deferred interest payments.
Biggest opportunities: In the current environment, some high-value transactions are still being considered and private debt funding will have a larger role to play as a lack of visibility on these transactions reduces competition from banks.
The best opportunities are arising from our role as an incumbent lender to existing portfolio companies, and also where the competition from some peers is weaker. We are also contacted by private equity sponsors we have long and established relationships with to consider proprietary situations.
Due to the dislocated market conditions in the secondary leveraged loan market, we anticipate a repricing of primary situations. ‘New normal’ conditions should reflect higher pricing with a better adjusted risk/return reward as leverage should also be lower.
Legal documentation terms should become more lender-friendly as well.
Opportunities across the secondary market, given both the strong position of LPs and the ability to offer discounted debt for financially stable companies, will provide attractive returns and opportunities.
There will be big winners out of this crisis – more digitally-agile companies that are already used to working remotely and from various locations should have an advantage, and we expect remote working to carry on after the pandemic crisis for some businesses.
Being a people business, knowing our investors and our portfolio companies very well, makes a big difference and we continue to be in close contact with all of our portfolio companies.
Khizer Ahmed, co-founding partner, Elm Ridge Advisors
Biggest challenges: We continue to witness the after-effects of sharp sell-offs in public markets, heightened volatility across multiple asset classes and a seemingly unending negative feedback loop between financial markets and the real economy. Lenders, including those in the fund financing space, appear to be making concerted efforts to conserve liquidity by restricting the availability of their balance sheets in financing transactions. The long-standing (and understandable) tendency amongst lenders to slow down the pace of lending in periods of stress in financial markets appears to have been exacerbated this time around by the unusual sight of vast swathes of the economy having been forcibly shut down to help deal with the coronavirus pandemic.
The consequent impact on future earnings of companies and on their valuations is still unknown and it is possible that reliable valuation data may not be available until well into Q3 of this year. This makes it difficult for lenders to reliably calculate the ‘V’ in LTV ratios, and fears of a substantial erosion in equity cushions is likely to put a dampener on lending to both private equity and private debt funds, both for new deals and in refinancing facilities that may be coming up to maturity. The drop in funding will probably coincide with the emergence of liquidity challenges in individual portfolios, and with a desire on the part of portfolio managers to take advantage of buying opportunities that are almost certain to present themselves in the coming months.
Biggest opportunities: This period of heightened market stress will reinforce amongst borrowers the benefits of diversifying their lender base with respect to meeting their fund financing needs. Specifically, the attractiveness of sourcing liquidity from non-bank lenders such as specialty finance companies/funds and institutional investors such as insurance companies and pension funds is likely to become more evident.
Specialty finance companies that operate in the niche space of providing fund-level financing in concentrated NAV transactions are likely to see a higher level of interest as sponsors recognise the flexibility provided by fund-level financing solutions in dealing with financing challenges around individual portfolio holdings. Institutional investors such as insurance companies and pension funds have a materially longer funding time horizon and the ability to offer highly bespoke covenant structures in fund financing transactions as compared to traditional bank lenders. Consequently, they are better positioned to help borrowers deal with the detrimental effects of the withdrawal of liquidity precipitated by the (seemingly) correlated actions of traditional lenders.
Claire Madden, managing partner, Connection Capital
Biggest challenges: It is at times like these that a fund manager’s approach to investor relations comes into the spotlight. Many managers will not have experienced a dislocation like this, and while portfolio management is bound to absorb a large part of the firm’s resources, it is really important to be transparent and upfront with investors, particularly where assets are at risk, distributions may be recalled, or urgent drawdowns for rescue finance may be forthcoming. How this is handled by the firm, regardless of eventual outcome, will have an impact on ongoing relations and willingness to commit to future funds.
Biggest opportunities: We have been allocating capital to secondaries and special situation strategies over the past 18 months. These funds have relatively small portfolios but significant dry powder so are well placed to acquire assets at attractive prices from motivated sellers. We are also active co-investors and are keen to work with private equity sponsors which may have a finance need within their portfolio but, with a fully invested fund, require a flexible third party to provide a solution.