The resulting weakening of covenants was compounded by the way many unitranche funds structured transactions by inflating EBITDA, allowing them to make larger loans without declaring higher intrinsic leverage. Ultimately, this meant that many lenders had found themselves in aggressive loan structures with fewer options when it came to maximizing their collections in bad credit.
Today, a range of funds faces a difficult future. As governments wean economies off budget support measures and the harsh realities of the economic crisis set in, many private debt providers can find themselves with the sack.
Where default problems have arisen so far, management and lenders are also being urged to delay their fate in the hope of a better recovery, taking a rapid restructuring approach. But any delay will lead to lower recoveries in the longer term, as struggling companies still bleed cash and face an uncertain future.
In fact, next year it could lead to the emergence of a large number of zombie companies, struggling to cover piles of large debt, which will be a concern for lenders who have not been willing to deal with it. issues in a direct and open manner. way.
Some loans will already be recorded at a loss on the books. These losses have already forced many direct loan funds, which still have important dry powders to deploy, to seek less cyclical credits to dilute the losses of their portfolios. But these less cyclical companies do not need more flexible termsheets, given their natural stability, and place more emphasis on the price of debt.
This has forced many Unitranch lenders to tackle pre-crisis loan losses as they struggle to lend at returns in line with their fund targets to strong non-cyclical companies during the crisis.
An engagement trigger is an early warning sign that allows lenders to meaningfully engage with management and find appropriate solutions as early as possible – the key to a successful outcome in direct lending. For too many loans in the market, covenants are more accurately described as a last minute notification at a time when lenders need all the warnings they can get. This thinking leads to larger losses in the long run.
Patrick Marshall is responsible for private debt and CLOs within the international business of Federated Hermes Inc., based in London. This content represents the views of the author. It was submitted and edited according to the Pensions & Investments guidelines, but is not a product of the P&I editorial team.