Global credit funds & CLO's
May 2020
| Issue 223
Published in London & New York.
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Opinion direct lending
Randy Schwimmer
Liquidity is king. A company with a sound long-term value proposition may not last the next few weeks
Head of capital markets and origination
Churchill Asset Management
May 2020 | Issue 223
In early December your correspondent was interviewed by a top private credit analyst about the economic outlook for 2020. “Do you expect a recession next year?” she asked. “I’ve wrongly predicted downturns since 2016,” I said. “I’m much less worried about a recession now. So watch: we’ll have one in March.”
Little did we know the trigger had already been pulled. And the projectile came not from mortgages, high-tech, North Korean missile launches or leveraged loans, but — it seems likely — a food market in Wuhan, China. The covid-19 pandemic, like the devastating 1918 flu epidemic, combines economic cessation with a threat to personal health. Today, uncertainty is driven by rolling production stoppages, inventory shortages, worker absenteeism and consumer stay-at-home-ism. When the virus runs its course, we wonder, will life — and commercial activity — return to normal?
Predicting the future is almost impossible
In the economy, variables are legion and interrelationships complex. Interest rates are at astonishingly low levels, which hurts yields but helps borrowers. Volatility challenges valuations, yet makes prices affordable. Throw oil into the mix — lowering operating costs and pummelling energy companies — and it’s a puzzle inside an enigma.

“The capital markets went from price perfection to price combustion,” one top credit manager told us. “Secondary leveraged loan trading is very active, but there’s a major bid/ask spread with liquid names. And it’s early days. We still don’t know what the rating agencies will do.”

Meanwhile, private equity firms have their own challenges. “We did not underwrite for this,” a partner says. “We always model downside scenarios, but the zero-revenue case wasn’t one of them.”

Since the coronavirus emerged, sponsors have been analysing how it will affect portfolio companies and add-on transactions. Liquidity is king. The long-term value proposition of companies may be sound, but they may still not have sufficient cash to survive the next few weeks.

Liquidity is also the number one concern among credit providers. Over half of revolving credit commitments have been drawn. Included in these worries are delayed draw term loans (DDTL). Employed typically for add-on acquisitions and significant capital expenditure programmes, borrowers may choose to interpret DDTL language to include more general purposes.

For lenders the focus on new deals has pivoted to existing credits. The pace of portfolio reviews has quickened and sponsor dialogue has accelerated strategies to battle covid-19 headwinds.

Are portfolio managers seeing a rush of amendments? What about payment defaults? “It’s early days,” one credit veteran says. “Companies had cash for 31 March interest payments, but 30 June is a long way off.”

“We are working very closely with our sponsors,” another top lender reports. “The majority are being cooperative about being part of a solution. But visibility on their businesses is near zero. They don’t know how much capital they’ll need because they don’t know how bad it’ll get. The outlook changes every day.”

Are bargains to be had? Perhaps, but who’s willing to step into a falling elevator? We suspect that once some stability returns, big investors will start making bets on brand names (consider Warren Buffett and Goldman in 2008). That will embolden others to dip their toes.
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Getting back to business in Q4
One credit shop head says it will take a while for the covid-19 cycle to play out. “But we know the game of big purchase price and leverage multiples is over. It’s too early to know where the new leverage and pricing models are because there’s no way to form a realistic cash flow forecast.”

He adds that commercial activity for the second quarter will be off sharply, but expects some improvement by the end of Q3. “Some one-off transactions will get done with wide spreads and discounts,” he says. “But there’s little conviction at the moment. Some normality should return to financing markets by the fourth quarter. Our job right now is helping our sponsor clients maintain the value of their companies until then.”
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For borrowers — and credit providers seeing revolvers drawn down —liquidity is the greatest concern
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