By Treabhor Mac Eochaidh, Head of Debt Services
The extreme market volatility and uncertainty brought on by the COVID-19 pandemic is widening the discrepancy between buyer and seller expectations for private assets. This is putting unique pressure on debt covenants and legal documents. Disruption to transactions are quickly increasing as banks put new deals on hold and multiples compress from over six times earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2019. As the industry is experiencing record levels of dry powder needed to be spent, distressed debt funds are well placed to take the lead while private lenders are poised to fill the gap of banks retreating. The global financial crisis (GFC) in 2008 caused similar economic and financial disruption. However, this time around private debt funds have more than three times the assets under management with significant capital to be deployed and that may provide financing and liquidity that was not available during the previous crisis.
Covenants and legal documents are likely to be tested
It’s clear that in the wake of the novel coronavirus pandemic we are going to see an increase in distressed / private debt. There will be lead-in time as covenants are breached, and lenders and borrowers assess all options open to them, with a swing back in favor of lenders but it will look different to post GFC.
Defaults on payments will be what comes through first and we expect to see a lot of amend and extend restructuring to help borrowers get through the short-term to mid-term liquidity gap.
The speed at which this downturn is unfolding probably means that covenant-lite loans will trigger quicker than expected. Alternative lenders on these loans will be able to look at the price of the collateral which will have dropped considerably and use that as the trigger. If the investment strategies are more credit opportunity focused for example, they will be looking at the fundamentals of the borrower over the long-term.
For many lenders, this is the first time loan documentation will have faced major tests to see how well they protect all parties.
Managers are positioning themselves to work in the direct lending space
Even prior to this pandemic, direct lending established itself as an asset class over the last decade. Thus, the industry is more mature for both lenders and borrowers to seek opportunities. More managers are positioning themselves to be in the best possible position to work in the direct lending space.
Managers are going to be focused on being opportunistic. They’ll be looking at how they can best handle opportunities coming down the road, looking at which companies are overleveraged in the short term but are fundamentally strong companies.
MUFG Investor Services: a partner ready to support new business
As allocations to direct lending rise, it’s critical that institutional investors understand the bespoke nature of and the risks associated with the asset class. MUFG Investor Services are ready to support new business as well as build on existing relationships in the direct lending space with a loan ecosystem designed to ensure the quality and accuracy of this complex asset class.
MUFG Investor Services direct lending operating model includes a powerful and flexible loan record keeping platform that models complex loans and tracks ongoing principal and interest activity over the lifecycle of the asset (acting as a sub-ledger to other core platforms).
If you’re pursuing direct lending, syndicated loans and distressed debt, look no further than a team of experienced industry professionals strategically located for all time zone requirements and reach out today. For more information and queries our debt team can be reached at [email protected]