Q4 2020
The dust is still to settle
Michelle D’Souza
Direct lenders and other experts give their prognosis for 2021 as the industry readies to bounce back from the dour times of last year
The conditions are right for a strong 2021 for direct lenders
Direct lender: Natalia Tsitoura, managing director and head of European private debt, Apollo Global Management

In Q4 2020, you could be forgiven for failing to find signs of the pandemic in the direct lending space, with incredible deal flow volumes more than compensating for the H1 plunge. PE sponsors largely dealt with internal portfolio issues and focused on deploying new capital, driving appetite from direct lenders. This seems set to continue in early 2021.
In 2020, lenders favoured defensive sectors such as telecoms, business services and healthcare, while largely avoiding industries impacted heavily by COVID-19, such as retail, travel and leisure. As lenders, the challenges are sourcing the right kind of deal flow and pricing that risk accordingly.
We expect COVID will continue to accelerate trends visible in the US market, including increased ticket size for deals. This is due in part to larger funds being raised, greater education on the benefits of direct lending, banks retreating and syndicated markets pulling back in times of stress. It’s a perfect storm for direct lenders, who are well positioned to fill this void.
The latest European lockdowns will clearly be a challenge for some portfolio companies, but, overall, we think 2021 will be a great lending environment, particularly as M&A activity accelerates.
Should challenges arise, direct lenders can work with borrowers on potential solutions to address their varying liquidity situations and capital structures. For example, late last year, Apollo worked with US media company Gannett to refinance around US$500 million of debt. The deal generated savings for Gannett, extended debt maturities and put the company on a path to refinance the outstanding portion of the loan on favourable terms in 2021. This was possible because of our close connectivity to the company and belief in their long-term strategy. Cases like this illustrate plainly the benefits of private credit and why we think the asset class will continue growing in Europe.
The story of 2021 will be the health of portfolios
Direct lender: Paul Johnson, partner and head of direct lending, Bridgepoint Credit
It comes back to what you’ve been doing for the last two or three years; we have invested around 85% in defensive sectors, such as healthcare or software with recurring monthly revenues, and that resilience has played out well. However, lenders with meaningful funds and on their second or third vintages are not coming into this with an entirely clean portfolio. And with recurring waves of COVID-19 infections and attendant lockdowns, recoveries may take longer than expected.
One positive takeaway is that LPs can really assess the level of risk managers are taking and are able to differentiate the managers. That was not the case a year ago. Managers were showing similar leverage levels and 8-10% returns on their pitchbooks. If you returned 10+% then, you were probably taking on more risk which is now manifesting.
LPs appreciate the more granular, data-led assessments. Companies were often assessed on a subjective traffic-light system, where lenders knew which ones were more exposed to a downturn or economic shutdown. Now, LPs are asking tougher questions: What happened to leverage? Did you miss any interest payments? Have you breached covenants?
They can also see the ‘real’ portfolio health and cut through some of the creative COVID adjustments going on. Lenders are not fooling anyone but themselves using those adjustments.
We remain bullish on new deal flow. Q4 was our busiest-ever quarter in terms of deployment, partly due to a market rebound in terms of volumes, but also due to the enlarged EQT/Bridgepoint team, with more local offices able to address sponsors’ needs. We had our first pipeline call and many of these are in their early stages, but it now certainly feels busier than previous opening quarters. Direct lending as an asset class should come through this crisis well and increase in relevance for its investors for future funds and PE.
Much time still to pass before dust begins to settle
Debt advisory: Patrick Schoennagel, managing director, Houlihan Lokey
By and large, private credit lenders have done well to navigate the challenges of 2020. But new lockdowns could wreak havoc in a lot of portfolios, depending on how long the crisis persists.
Many companies were able to get through last year thanks to government assistance, lenders being flexible and covenant waivers. That said, there is going to be some fatigue with lenders and, ultimately, instances of covenant breaches.
Good companies with reasonable balance sheets will have to have some tough discussions with their creditors depending on how the current lockdowns evolve. Not many companies’ leverage covenants, even when set as loose as they have been, will be able to withstand the pain inflicted by a year-and-a-half-long severe reduction in economic activity.
Companies that only have a financial covenant and not a liquidity problem will have already been placed on the ‘OK’ list. The real focus in the next three to six months will be companies where a recovery was expected to have begun and that upturn is further deferred due to fresh outbreak of COVID infections and subsequent lockdowns.
It will be interesting to see which lenders have the organisational wherewithal to continue deploying capital into new transactions in the face of renewed uncertainty. It’s likely that several private credit providers will be preoccupied with portfolio matters, as these discussions take up a great deal of time. Lenders that have several triage cases in their portfolio but are not big enough to have a separate workout team to address them will likely need to take their foot off the pedal for new deals due to resource constraints.
For all that, 2021 has opened with a robust pipeline. One factor that has spurred UK activity is the upcoming budget, with many shareholders looking to sell quickly before any change in capital gains taxes. However, the dust will only settle in around two years’ time when one can see longer-term fund performance.
Buying time to enable the recovery of good businesses
Leverage provider: Arun Cronin, managing director, Credit Suisse
Some leverage facilities contain valuation haircuts based on financial metrics such as a company’s debt/EBITDA ratio. These haircuts can be quite punitive in an environment where market dislocation, such as that engendered by COVID-19, has caused debt/EBITDA ratios to spike in the short term. The application of these haircuts can cause facility loan-to-value ratios to become elevated, potentially triggering events such as cash flow sweeps and reducing cushions to event-of-default thresholds.
We were able to work with our borrowers to provide borrowing base stability through this period of dislocation by waiving some features that were adversely impacting the borrowing base and to avoid LTVs under our facilities becoming elevated. We took this approach to give companies in the most impacted sectors time to recover – a good business does not automatically become a bad one because of lockdowns. We have found that the underlying companies have generally had adequate liquidity runway to survive the series of lockdowns that have occurred.
There were signs of recovery in H2 2020, but the impact of the second lockdown in Europe will again hurt earnings and increase leverage in certain sectors. However, we will not get March financials until well into Q2 and, hopefully by that stage, COVID-19 vaccines will have been rolled out more widely and companies’ revenue lines will have stabilised.
New deal flow remains strong with a lot of private credit funds continuing to raise a levered and an unlevered sleeve. We remained active throughout 2020, doing our first post-COVID facilities in late Q2.
At the height of the pandemic, spreads blew out from the low-to-mid 200s to the low 300s. They have now tightened to the mid-200s, depending on the manager and strategy. Other risk terms such as eligibility criteria, super senior tolerance and principal cash sweeps have also tightened slightly, but the differences are not especially meaningful.
The two types of troubled company
Lawyer: Aymen Mahmoud, partner, McDermott Will & Emery
Uncertainty amid global markets favours private debt, much as it did in 2008, where many banks will be increasingly mindful of tighter regulation and lending practices. Direct lenders are best placed to take advantage of this in the case of bank inaction and relative certainty of transactions versus syndicated bank loans, evidenced by their continued involvement in M&A throughout H2 2020. They can also act as strategic partners to their borrowers, using patient capital to take minority equity positions or kickers to align interest, something that banks tend not to do outside of a restructuring. This will no doubt continue into 2021 as COVID-19’s impact endures.
Overall, lenders seem to have managed their portfolios effectively. But it is difficult to see the precise nature of the impact – auditors are taking longer to provide audits, there remains uncertainty around supply chains and extended payment terms may be needed to shore up counterparty liquidity rather than it being indicative of underlying issues. Government intervention, which can mask certain issues, makes it difficult to identify liquidity needs in credit markets.

Still, there remains a strong appetite for the asset class. In the event of a sustained period of impact, there will be some consolidation among asset types or verticals. PE firms, with significant levels of dry powder, will take advantage of any reduction in pricing to bolster existing portfolios. Sponsors have historically been wary of burgeoning prices and the increasingly competitive nature of M&A, so any dip will act as an incentive to transact. Lenders remain very interested in defensive sectors such as technology, healthcare and software. Pet food businesses were also popular last quarter.
Documentation remains focused on deep underlying credit questions such as dividend levels and debt incurrence. Anti-hoarding or liquidity covenants, terms that people were talking about when the pandemic first struck, are less prevalent today.
There are really only two categories when it comes to troubled companies: the ones that need to restructure and the ones that need some liquidity to get them through the next three to six months. The plethora of special situation funds that can provide some of that more opportunistic capital, alongside the direct lending dry powder out there, means we do not have that liquidity drought we had in 2008.
For companies restructuring in the UK, new insolvency legislation has made things more efficient about who is going to get what, and it has made it a bit more difficult for distressed hold-out creditors to extract value where they have no economic interest. Whether in unitranche or super senior structures, it’s a step that enables enhanced credit analysis.
Flow was low, but dialogue is on the up and up
Private debt secondaries: Olga Kosters, managing director and head of private debt secondaries, Tikehau Capital
Following the volatility in public markets, deal flow alleviated in H1 2020, but we saw a marked uptick in enquiries from people who had previously not engaged in the space. We expect this trend to continue in 2021.
Private debt secondaries volume for 2020 was around US$5 billion-US$10 billion, with direct lending responsible for a large part of that flow. However, given Europe has historically been behind the US, there is a smaller universe of primary funds and that is also translated into secondary volumes. That being said, we did see some interesting deals in the European direct lending space last year, both older vintage LP stakes and GP-led deals.
LPs started looking at their existing portfolios differently – instead of buying and holding funds until the end of funds’ lives, some LPs started taking a proactive view and the secondaries market benefited. Deal flow was also driven by volatility in public markets. Several LPs took a ‘risk-off’ stance, adopting a more cautious approach to future allocations, which also trickled into private debt secondaries. Private market volatility brought some very interesting valuations from the buyers’ points of view.
GPs took a more creative and active approach in 2020 and are looking at the secondary market as a tool set – either solving for the duration of the older vehicles and moving out some assets into new vehicles, diversifying their investor base or other considerations they are trying to find a solution for. Each deal is different, but there has certainly been more dialogue in the space.
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European Direct Lending Perspectives
Q4 2020
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