Global credit funds & CLO's
February 2021
| Issue 231
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February 2021 | Issue 231
Opinion Direct lending
A year that looked like it would be a total wipe-out ended up being very constructive indeed
Randy Schwimmer
Head of capital markets and origination Churchill Asset Management
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Our columnist looks back at some of the surprises of 2020
In a year that redefined surprise, many unexpected developments impacted the world of private capital. For Creditflux readers, here are five noteworthy ones.
Market snap-back
Hard to remember now, but last March the Dow plunged almost 11,000 points in less than six weeks. No one knew at the time, but public equity valuations had bottomed out. If you panicked and went to cash you crystallised your downside and lost considerable upside.
The same held true for liquid credit. The S&P/LSTA Leveraged Loan Index hit a low of 76 that month, a drop of over 20 points, then climbed back towards par. It closed the year at 96.
Private equity and credit values demonstrated much less volatility. Investment pace was driven not by market technicals but the tyranny of dry powder. Uninvested capital burned holes in managers’ pockets for five months. With plenty of liquidity in the system (and with fund general partners), overall markets detached from both the virus and the economy.
Non correlated trends
At the lowest moments in both the global financial crisis and the ‘global biological crisis’ asset prices swooned in sync. Bad news sunk everything. To paraphrase Tolstoy, happy markets were happy in different ways; unhappy markets were alike.
When valuations recovered after the 2008 financial crisis, cumulative correlation rose among liquid loans, high yield bonds and stocks. As the 2020 crisis progressed, capital flowed out of coronavirus-impacted businesses and into the rest. For buy-and-hold investors of non-traded, middle-market assets, the health of existing credits is paramount. The best course is to work with private equity owners to get through tough times.
Where’s all the distressed credit?
The speed of the US Federal Reserve’s rescue helped ease problems for large corporate issuers. Similarly, private equity owners jumped in with capital injections and management support. Lenders supplied revolving credit liquidity and adjusted covenants to ease financial burdens.
This flexibility minimised the number of distressed borrowers in the private credit market. Rather than facing a raft of quarter-end defaults, direct lenders found that only about 15% of their borrowers breached financial tests.
Sector distinctions
The bifurcation between ‘have’ and ‘have-not’ industries was clearly defined once covid-19 took hold, but what surprised observers was the persistence of that trend.
For the haves, that consistency lent momentum to deal-making in the second half, regardless of infection rates. The have-nots — retail, restaurants, consumer discretionary, travel and hospitality — saw little or no recovery. That’s certainly not to say all retail was negative. Online shopping sites swung briskly to the plus column. But consumer-facing industries remain challenged and it’s too early to tell what their new normal will look like.
M&A upswing
By mid-2020 owners of performing middle market companies realised valuations could exceed pre-covid levels. The potential for higher capital gains taxes in 2021 might also result in more cash in sellers’ pockets.
PE buyers, buttressed by significant dry powder, and reluctant to explain to their fund limited partners why so few deals were being done, jumped in. That caused a ramp-up in deal activity after Labor Day. This M&A surge pushed purchase price multiples to record highs for better businesses. The challenged companies either could not be sold for any price or had to deal with deeply discounted multiples.
Like everyone, private market participants will look back at 2020 and marvel at how unprecedented and pervasive the pandemic turned out to be — and how disconnected it became from the overall markets. Perhaps the biggest surprise, if you were an investor in private capital, was how a year that looked like it would be a total wipe-out, ended up being very constructive indeed.
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