Private debt emerges from crisis despite fears of loose trading conditions
When black stoneThe private debt branch hit a close of $ 4.5 billion on its second European direct lending vehicle in March, the achievement quickly overshadowed by larger events – just three days later, the UK Uni, as well as much of Europe, were totally blocked.
The year 2020 had started well, with two other large direct loan funds having reached their end in the previous weeks: Ardian closed on 3 billion euros (about 3.6 billion dollars) for its fourth flagship credit fund and its US counterpart Churchill Asset Management raised $ 2 billion for its second mid-market fund.
Deploying capital on Zoom is not the only new challenge these managers are facing. In addition, they must steer funds from a relatively new asset class through uncharted waters in the face of unprecedented economic headwinds. And despite fears of the industry’s exposure to private debt as this year approaches, there are few signs of serious problems so far.
Of course, important concerns are still relevant today. Few of today’s private debt managers have weathered a severe global recession. Most active businesses sprang up after post-2008 regulations pushed traditional commercial lenders out of the market. In addition, a decade of flexible loan requirements has left some managers and their borrowers overexposed in the face of a market downturn.
The way managers navigate their portfolios during the pandemic crisis – minimizing defaults and seeking new opportunities – is expected to shape how limited partners allocate capital to private debt for years to come.
As a sign of increasing pressure on fund managers, some debt funds are already focusing their transactions on more conservative bets, dividing the market between the haves and have-nots.
“What you’re going to see, I think, over the next few months is that a lot of people will try to make deals in very safe areas, which means that the yield will be very tight in that part of the market due to the defensive nature of these companies, ”said Symon Drake-Brockman, managing partner of a London-based private investor. Pemberton. “But some people will be very willing to be flexible about the documentation because they are desperate to get the money to work. We think you will have to be selective.”
Overall, fundraising from debt-focused managers has slowed significantly this year. In the first half of the year, 53 funds raised a total of $ 47.8 billion, far less than the $ 68.2 billion raised in the same period a year ago, according to PitchBook. Report on global private debt for the first half of 2020. Agreement activity also declined. Only 2,335 debt investments were made globally in the first half of the year, the lowest number in six months since at least the start of 2015.
“For the first month or so [of the pandemic], private equity and private equity firms were sorting through their portfolios, “said Randy Schwimmer, senior managing director of Churchill Asset Management.” Like a hurricane passing through, you make your way to shelter, then emerge later to assess the damage. “
So far, private debt managers and their investments, on the whole, have shown resilience, as evidenced by the relative absence of defaults. According to Proskauer, a law firm that tracks private debt lending in the United States, the third-quarter default rate was 4.2%, up from 8.1% in the second quarter, and even below the rate of 5. 9% in the first three months of the year.
Many borrowers were able to draw on existing revolving credit facilities to complete them. This type of credit allows holding companies to withdraw money, pay off debt, and withdraw again on an ad hoc basis. Some companies have also benefited from additional support from their private equity sponsors.
“Private lenders were pumping equity into companies that needed it and negotiating with lenders to give the companies enough leeway to operate without triggering a pact,” Schwimmer said.
Nonetheless, concessional loans to borrowers in the overheated pre-crisis market may still have left lenders vulnerable. In credit markets, these “covenant-lite” agreements are essentially unfettered loan agreements that give borrowers a lot of leeway. While conventional loans have been less common in middle market private debt, so-called covenant-loose loans, which have less protection, have crept in. These loans accounted for 59% of transactions completed by the company’s clients in 2019, according to Proskauer Data.
“I think some of the managers were pretty aggressive in trying to win conditional deals, and they ceded a lot of control over the deal to the sponsors,” said Pemberton’s Drake-Brockman, who added his company had avoided the distress of his wallet. because their commitments reduced the risk of borrowers defaulting.
The fact that a company defaults is not simply the result of the strict way managers set the terms of their contract. The unprecedented way in which the pandemic has affected some sectors more than others means that companies that would otherwise have weathered a conventional economic downturn have felt the pain disproportionately. Meanwhile, some industries have been better insulated.
Private investors exposed to travel, hospitality and especially retailing were the biggest losers after being shut down during lockdowns. A number of US retailers backed by private equity firms have gone bankrupt, among them J Crew and Neiman Marcus.
Cécile Lévi, head of private debt in Paris Capital of Tikehau, said she expects the market to become even more forked than it already is today. More capital will be raised through less funds, as LPs focus on managers who bet on safer industries or those that are large and diverse enough to absorb losses.
“I think there will be more consolidation in the market,” Lévi added, “or at least there will be some managers who find it difficult to raise new funds.”
In the meantime, struggling debt managers will also be looking for new opportunities. This year, a larger share of the overall capital raised was devoted to troubled debt funds. With special situation vehicles, the strategy accounted for nearly 30% of fundraising in the first half of the year, compared to just 19.7% for all of last year, according to data from PitchBook.
Not only Oaktree Capital in the market with a new troubled $ 15 billion debt fund, but Global management of ApolloThe $ 24.7 billion IX Fund changed its buyout strategy to credit and distress-for-control opportunities in May. The company is looking to raise an additional $ 20 billion for COVID-19-related distress opportunities in the coming year.
“There has been a lot of capital raised for troubled high yielding debt targeted at businesses affected by COVID where existing lenders are looking to exit,” Churchill’s Schwimmer said. “[But] these opportunities have not arisen in number because lenders and private equity sponsors work closely to maintain liquidity in these companies. “
Image featured via Oscar Wong / Getty Images
Note: The chart in this story was corrected on December 14 to accurately reflect the size of Apollo Strategic Origination. The size of the fund is $ 12.53 billion, not $ 2.53 billion as previously stated.