This article is sponsored by Ocorian
Debt finance activity has been on the increase in recent months as companies seek to mitigate the effects of the coronavirus lockdown. As fund managers begin to emerge from the initial shock of the crisis, focus is shifting to opportunities in distressed debt and special situations, says Alan Booth, managing director at Ocorian, a global leader in fund administration, capital markets, corporate and fiduciary services.
As we emerge from the immediate impact of the coronavirus lockdown, what effect have the last few months had on debt finance activity?
Ordinarily, you would expect to see bond issuance declining in the event of falling GDP, but that really hasn’t been the case in the first two quarters of 2020. With the covid-19 restrictions on society and economic closures, there is a sizeable decrease in consumer demand, but an increase in household saving and an increase in corporate debt as the vast majority of people continue to practice social distancing, avoid the high street and work remotely. For companies to survive, they have drawn heavily on revolving credit facilities, drawing down $340 billion across the US and Europe. The US market has diverged slightly from Europe, focusing heavily on long-term bond issuance, whereas in Europe the focus has been heavily on commercial paper.
Ocorian has been involved with two of the largest commercial paper issuers in Europe, so we have seen the level of activity gradually increase. Commercial paper is a relatively cheap funding tool, so in the first two quarters issuance reached €35 billion in Europe, which is well up on last year, and we expect that to continue as the US continues down the long-term bond issuance route.
What kind of activity are you seeing around special situations funds?
Ocorian works very closely with a diverse range of fund managers, who are adept at spotting opportunities and have accelerated the level of fundraising within pre-existing special situations funds and new ones coming to the market. The appetite, particularly among US and to a lesser extent European and UK fund managers, to take a sizeable position on distressed debt is becoming a key theme for Q4 and will be a theme throughout 2021.
At Ocorian, we look to service our clients at the portfolio level and facilitate our clients with structures, from fund creation and work-out scenarios, through to investment holding, staff incentivisation and on to exit. At the moment, there is a strong focus on fundraising, looking at corporate targets in default, and there is a lot of capital ready to deploy and starting to be deployed, not necessarily just on distressed assets, but on corporates that continue to be a going concern but which are currently under-priced due to market conditions.
The sectors in the spotlight right now are really any relating to supply chains around the automotive, airline and retail industries. Then there’s also the Brexit play alongside covid-19, which makes UK target acquisitions that little bit more attractive. So, we will certainly see that deployment continue. We are seeing government and central bank support coming to an end, while there is pressure on traditional bank lenders to go easy and not trigger loan defaults. As that government support is withdrawn in Q4 and bank lenders roll back on their support, certainly in the UK we will see the need for special situations funds to be deployed.
What role are the direct lending funds playing, and how is that impacting the market for both loans and private placements?
What we are seeing in the Asian market is particularly interesting and will have an effect on inward investment to Europe and the US in the short to medium term. There is now $850 billion globally in private credit, and in Asia, their direct lending generally comes into Western economies and assets. Those outflows are being pulled back, both to de-risk and to channel more investment into their home markets. That is something we are focusing on in Singapore and Hong Kong, which includes understanding the nuances of the local markets. We are building out what we can do around direct lending platforms and private placements in Asia.
In Europe, we are currently in the process of setting up a number of private placements and that activity has been unphased and continues to grow. That dovetails into the need for funding not related to the banks, who are pulling back and are being replaced by private equity players like KKR and Apollo, who are stepping up from the mid-market to look at listed corporates for investment. Those large players are deploying a lot more capital than ever before.
What trends are you seeing in how private equity firms and their portfolio companies are making use of different debt structures?
Private equity firms have largely been closed off from government support in the UK context, and are in many cases heavily exposed to sectors like retail and hospitality that have been severely impacted by the pandemic. We are seeing a sizeable increase in the number of restructurings and defaults and in our London team we significantly bolstered our restructuring expertise at the start of the year to help with that.
We are very focused on helping private equity and their underlying portfolios to come out the other side of the current economic challenges. Within that market, we are seeing a number of fundamentally strong portfolio businesses going through restructuring and workout scenarios, and we have been involved to some extent with a number of restructurings that were private equity supported, or working their way through refinancings.
Come Q4, I think we are going to see a crunch, with our colleagues in the legal market and the distressed advisory market starting to plan for a wave of restructurings going into 2021 and 2022.
Looking forward, do you have any predictions for how the use of debt finance might evolve through 2021?
Looking at equity finance, it is likely that new share issuance will continue and might be ideal for corporates that have robust balance sheets. On the debt finance side, debt is relatively cheap at the moment so that’s certainly going to continue at pace, with debt issuance set to increase significantly in 2021, though that largely depends on how long covid-19 is going to be with us.
There’s going to be wider industries that just will not come out well post-covid because of people’s behavioural changes, particularly relating to work-life balance. The likes of Pret A Manger will need to restructure as a result and will come back with a different shape and scale.
The debt funds are well-positioned and debt finance will be available for those businesses the market has confidence in. Where a business has fallen over or gone into insolvency, it may be that covid-19 has only exacerbated issues that were already there. But for companies that were well run and are well positioned, finance will be available, and funds are also going to be getting involved with larger corporates than in the past.
We will see the continuing retrenchment of the banks, which has been happening since the financial crisis, and those lenders will increasingly focus on the retail banking sector under pressure from government to support the wider public. That allows the private debt funds and private equity to position themselves well to go after a far bigger slice of the corporate market.