The private debt market returned surprisingly quickly in the second quarter, after a short but intense dark period after the COVID-19 hit, but much remains unknown at the end of the year, private lenders said in a webcast from global consulting firm Dechert LLP.
After spending much of 2019 fundraising, private lenders were in a strong position at the start of the pandemic, so credit was available to help businesses weather the uncertainty. As with banks, private lenders have focused on replenishing depleted corporate revolving lines of credit and providing additional loans.
Even though private credit was in a strong position, the volume of drawdowns on revolving lines hit some lenders hard, especially compared to banks, which were better able to meet borrower demand, in part due to their lower cost of capital.
“There was a bit of stress because of an unexpected drop of the gun and the extent to which it happened,” said Kristine Jurczyk, co-director of Vista Credit Partners. “It has forced some people on the private credit side to be in the market to generate liquidity in a sub-optimal environment.”
Some companies were well positioned to take advantage of the sudden downturn by offering bailout loans or, through their subsidiaries, equity injections to hard-hit companies, but the window closed surprisingly quickly. Before the end of the second quarter, the markets were improving.
“When we saw this opportunity present itself, we made a rapid increase [for] our new dislocation fund, ”said Cade Thompson, credit side partner at investment firm KKR. “The window probably hasn’t been open for as long as people would have liked. We’ve been able to deploy a decent amount of that and also deploy a decent amount of our private equity strategy. “
Among the transactions KKR concluded was a $ 500 million purchase of newly issued convertible preferred shares for US Foods.
Thompson said KKR would have liked to close more of these deals, but the markets quickly stabilized. The “deal-making machine was not fully ramped up at this point,” he said. “Going in and doing some of that bailout funding in the form of a favorite, or whatever you got, was the flavor as long as it lasted.”
Since the end of the second quarter, the primary and secondary markets have performed relatively well, and credit providers are now on the lookout for new deals, primarily for businesses expected to benefit from a post-COVID environment, lenders said. .
The activity of private lenders was flourishing this summer, more in the United States than in the United Kingdom or in Europe, but still relatively well even across the Atlantic.
“Europe is probably a little behind the non-bank lender market share penetration curve,” said Daniel Sinclair, Lending Team Partner at Ares Management.
Even so, the largest private equity firms were able to recover business that would otherwise have gone to the banks.
“Your large-scale operators with capital and resources, in terms of team size, have been able to take advantage of lenders who may be distracted by what’s on their balance sheet,” he said.
Banks, especially in Europe, have also focused on government-backed loans, leaving alternative opportunities to the private sector, including leveraged buyouts (LBOs).
“The government backed loans have taken away resources to potentially support LBO operations, which has certainly been a factor over the summer in Europe,” Sinclair said.
In a change, lenders say they are seeing more deals offering portability, an arrangement structure that allows loans to stay with the business after it’s acquired rather than replacing them with other financing.
The deals can help equity sponsors sell their portfolio companies quickly, and buyers may find the deal attractive because it simplifies the purchase, but critics say the benefits are questionable; they can leave buyers with debt that is not optimized for them.
“Joining exactly the same capital structure, with the same commitment profile, the same term … [that’s why] you get the debate, ”Sinclair said.
Until this sudden interest in portable transactions this summer, the structure hadn’t been seen much in recent years, although a deal KKR concluded just over three years ago with the banking consultancy firm. Evercore investment was portable.
The deal was attractive in part because of Evercore’s strength, including credit quality and the company’s recent performance, Thompson said.
Jurczyk said she prefers the deals not to have the structure. “To the extent that a loan is transferred, it means the market has moved against you,” she said. “So for that reason we don’t like it.”
Junior debt competition
Lenders have said that there is more than competition in the first lien market; the market for unionized second privileges is also strong.
“We continued to see increasing amounts of evidence [of] a deep and functional market for syndicated junior capital, ”said Thompson.
Syndicated accounts are looking for a junior component, he said, “to remove the first lien and extract the return.”
KKR was recently involved in a junior deal with contact lens retailer 1-800-Contacts.
“There were certainly private solutions available,” he said. “It was just our opinion that, given the speed to market… and the demand we saw in the syndicated market, [it was] will be a more optimal result for us as a transmitter. “
The big question for private capital at the end of the year is how much disruption is to come, lenders said.
COVID-19 is resurfacing, and the deadlines of the US presidential election and Brexit in the UK could create great uncertainty.
“My outlook is a little more proactive than defensive than it would have been in April,” Jurczyk said. “I’m better configured from a state of mind perspective as well as having the house to take advantage of the volatility. But I don’t think we’ve come out of the woods.”