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COVID-19 creates attractive direct lending opportunities
As featured in Preqin’s global private debt report, Ken Kencel, CEO and President of Churchill Asset Management discusses the impact of the pandemic on direct lending.
Q: How has COVID-19 impacted private credit investment activity?
After coming to an abrupt halt last year as a result of the global pandemic, the private credit market rebounded dramatically in the second half of 2020 and continued to get increasingly active through year end.
In fact, we saw record investment activity for our firm in the fourth quarter. For the first time in a long time, it’s a lender’s market. The long bull run in credit markets saw a rise in leverage levels, a steady narrowing in borrowing rates, and a general loosening in lender protections (e.g., covenants) as yield-starved investors competed to lend money to both public and private companies. In the middle-market lending space, this trend ended abruptly in March 2020, when the rapid increase in COVID-19 cases – and ensuing lockdowns – drove many companies to draw down revolving credit lines and some to reach out to debt and equity providers for covenant relief.
Since then, new issue loan spreads in the private credit market have risen, covenants have tightened and equity cushions have become more substantial, reflecting a significantly more lender-friendly market dynamic. We see the current environment as very attractive for private credit managers like Churchill that have the scale and deep relationships in the private equity community. While we are very carefully evaluating new transactions and remaining highly selective, we believe the 2020/2021 vintage for private funds will be particularly strong for market-leading managers (similar to the Global Financial Crisis). There are many companies today that are looking to raise capital that have not been impacted by COVID-19, or maybe even benefited from it.
Q: How has COVID-19 impacted private credit loan portfolio performance, and which sectors have outperformed?
Our focus on high-quality, recession-resistant businesses and emphasis on significant portfolio diversification proved to be extremely important. With minimal exposure to oil and gas, travel and leisure, restaurants, and retail, we have been well positioned to weather the pandemic. In fact, we did not experience a single COVID-19 related payment default or loss in 2020 in our investment funds. Interestingly, during the second half of 2020, we began to see a clear distinction emerge between the ‘haves’ and ‘have-nots’ in the private market. Sectors that have performed well – or in some cases, even better – during COVID-19 include consumer staples, logistics/distribution, online learning, healthcare services, software, and B2B businesses. We remain focused on these sectors as we evaluate new opportunities.
Many investors realize this vintage could be the best in years with attractive pricing, reasonable leverage, and better structures.
Q: Are investors looking at private credit differently today than they were before the pandemic?
The hunt for yield is still very much driving demand in private credit for institutional investors, particularly pensions, insurance companies, and endowments. We see this first-hand from our parent company, TIAA, who we invest on behalf of and retains a robust appetite for senior lending and junior capital strategies.
Investors are actively allocating to private credit and are very excited about the current market opportunity, but of course want to focus on companies that are not adversely impacted by COVID-19 and are more cautious about where to put their money to work. Many realize this vintage could be the best in years with attractive pricing, reasonable leverage, and better structures. Investors are seeking strong, differentiated GPs with scale and a great track record through cycles; experienced managers with strong relationships appear to have a clear advantage given the due diligence challenges and need for certainty of execution in the pandemic environment.