As we all do our best to adapt to the disruption caused by the outbreak of the global pandemic associated with the 2020 Covid-19 (“Coronavirus”), we thought it may be helpful to share some of the recent views and opinions expressed by FFP‘s colleagues and friends across the fund finance and broader private equity markets.
We’ll focus on four primary constituencies including (i) private equity funds, (ii) private credit funds, (iii) private equity real estate funds and finally, (iv) the traditional banks that lend to the aforementioned private fund sponsors.
We at FFP believe private fund sponsors have the ability to not only be assistive in pulling us out of the economic turmoil created by the Coronavirus but can and will be the primary economic savior. In January of 2020, Prequin estimated that private fund sponsors (inclusive all strategies) had over $2 trillion of dry powder. Many of these sponsors have been sitting on the sidelines due to what they viewed as overly high asset valuations. That concern will soon be rectified as it’s only a matter of time before those asset valuations fall given the sharp decline in public equities. Public and governmental aid is no doubt essential to recovery, but we mustn’t forget about the importance of private funds and their efficient deployment of capital.
Prior to jumping into the more sector specific thoughts, we thought it may make sense to identify a couple of the general fund finance market trends we’ve observed. First, many private sponsors are drawing down on their fund level credit lines; whether it be in support of portfolio companies that will need additional liquidity or building a healthy reserve to ultimately seize upon increasingly attractively-priced assets, the bottom line is, facilities are being drawn. As FFP foreshadowed here in a recent PEI article (Read Full Article), uncommitted lines are being put to the test, and we fully expect some interesting conversations surrounding draw requests on those facilities.
Second, to no one’s surprise, structuring of and executing on fund level financing transactions has been protracted and more delays are expected. This is understandable given the broad-based holdings of most large banks, and their respective credit committees ongoing review of their existing portfolios. We fully expect the fund financings to move forward and ultimately close; it will just take a bit longer.
As we navigate these uncharted waters together, in support of our friends and colleagues in the industry, we are briefly summarizing what we’ve observed. After all, FFP engages the entire fund finance ecosystem when partnering with our clients to help them achieve optimum outcomes.
Clients see grand opportunity in the buyout space. Of course, markets need to calm and asset prices need to settle, but private fund sponsors have for several weeks now been compiling lists of companies that are most likely to soon be in need of stabilizing liquidity. They believe they can act faster and be nimbler in response to some distressed opportunities than their corporate competitors. We’re hearing that most of the increased scrutiny and diligence will focus on how much the target’s supply chain has been impacted and how quickly it can be reconfigured to ensure (and resume) smooth operations. Surprisingly, we’ve also heard that some technology-related deals may be impacted far less, if at all, than transactions in other sectors.
Over the last 10 years, there has been no faster growing sector of private funds than private credit. The covenant light, heavily adjusted EBITDA, permissive post-closing covenant approach that no private credit manager professes, but many private credit sponsors have quietly adopted, will certainly be tested; MAC and force majeure clauses may be invoked. That said, most of these lenders are adept at working with their borrowers through challenging situations. Underlying revolvers will be drawn and there will be workouts. Several clients in this space have indicated there may be some overdue consolidation of portfolios and even managers. Not surprisingly, there are plenty of alternative lenders with sizeable amounts of dry powder eager to (i) review distressed portfolio opportunities that other private credit funds are willing to package and offload, as well as (ii) consider fund-level lending opportunities, especially in which struggling portfolio companies may be involved.
Private Equity Real Estate
Several of our larger commercial real estate fund sponsor clients acknowledged that they have been waiting for a pricing correction and they now have it. They also hint that much like the last downturn, there will be very little in terms of asset sales over the next 30-60 days, because no one knows how these assets should be priced in the new world. Regular users of leverage both at the fund and the asset-level, private equity real estate fund sponsors (like the rest of us) are curious to see just how inexpensive borrowed money is going to be after the dust settles. These sponsors are quick to remind anyone who will listen that the private real estate market is not the stock market; it takes time for the impact to be measured as leasing and rental fundamentals don’t change overnight.
FFP has spoken with scores of private equity fund finance lenders over the last few weeks, and we have been encouraged by those conversations. Aside from the disruption of working from home and the ever diminishing Team A/Team B rotational working arrangements being put in place, the vast majority of financial institutions remain engaged, responsive, and continue to move forward with the transactions we currently have in the market. This may in part be attributable to general optimism and /or an underestimation of Covid-19’s impact but there is no doubt that banks are in a better position than they were heading into the last downturn. The Federal Reserve’s institution of various “stress tests” has their capital positions, loan operations and credit teams prepared to deal with a significant amount of losses while remaining able to lend. These banks simply don’t hold as much risk as they once did and given the ever-increasing importance of private fund sponsor clients to their future, we expect positive outcomes for fund borrowers.
It’s far too early to tell, but we’re fortified by the feedback we’ve received by the hard-working principals at our primary constituencies. There obviously remains a great deal of uncertainty but one thing we are certain of is that the broader private equity markets will play an integral role in the global economy’s recovery. FFP will continue to work with its partners in the broader private equity industry, inclusive of traditional banks, professional advisors and regulatory bodies to insure that private fund sponsors continue to receive the support they need to effectively and efficiently deploy their capital during these most challenging of times.