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Lessons for Private Debt During COVID-19

Posted by: | Posted on: June 7, 2020

It’s a lot like the 2008-2009 financial crisis, except when it isn’t. Searching for comparisons to help map a trajectory out of the economic doldrums created by COVID-19 is only natural (and prudent), but the nature, speed and scope of the crisis presents a different and more complex challenge than a decade ago, especially for private debt. 

Preqin, a UK-based data and analytics company that tracks the alternative asset community, released a report in late May outlining the lessons it feels should be learned by the private debt market during the pandemic. 

Compared to 2008-2009, the private debt market is significantly (37%) larger and more diversified now, and although many credit the financial crisis with birthing the modern private debt market, the pandemic is where it grows up. 

The first “lesson” the report references is the importance of liquidity. Portfolio companies are more likely to need increased capital to survive this downturn, and private debt funds are well positioned to offer “supplementary” capital to those looking to prop up their portfolio holdings, the report said. 

The report also stated that fund managers should focus on existing investors, which the report notes is a deviation from 2008. The inability to have face-to-face meetings could spook potential investors that don’t have a previous relationship with a firm, and the report suggests that in light of that, it is more prudent for firms to work with those they know. 

Third, the report says that the darling of the last decade, direct lending, could “fall out of favor”. In 2007, directly lending accounted for $85 billion in assets. By June 2019, that number was at $222 billion. But the report suggests that upcoming opportunities are more likely to be in highly leveraged companies, giving an advantage to mezzanine funds and distressed debt at the expense of direct lending. Direct lending, the report states, will most likely be more attractive once the recovery begins.

Finally, the report emphasized a cooperative dynamic between the borrowers and lenders. Due to the abrupt nature of the economic changes fostered by the pandemic, most companies are going to have liquidity issues regardless of best laid plans, and building a strong rapport to work through potential issues together would be wise for all parties, the report stated.

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