Executives also have increased the level of discussion with management teams and sponsors, and have "proactively been engaging with other stakeholders to find collaborative solutions for companies that are more affected," she said. Portfolios are mainly exposed to the health care, and information technology and software industries, "which has meant more optionality for businesses that have been affected by COVID-19," Ms. Downer said.
But managers are also having to manage some important unknowns as they work with their portfolio companies through the crisis: Just how long this pandemic will last, when the serious impacts of the lockdowns will actually hit portfolio companies the hardest and how to value the assets in their portfolios.
"It also depends on whether a business is overleveraged," said Paul Shea, co-founder and managing partner at private debt manager Beechbrook Capital LLP in London.
Figuring that out is easier said than done.
"It is unclear who is overleveraged, and who is not, at the moment. Each investment needs to be assessed on a case-by-case basis but, ultimately, companies need cash to service debt. Due to the uncertainty and disruption to sales and cash flows, it is hard to assess an accurate EBITDA number (right now) for valuation purposes," he said, adding that choices include using a pre-COVID 19 EBITDA or "discounted future cash flows following an assessment of going concern." Executives at Beechbrook, which has about €900 million ($1 billion) in assets under management, use a combination of methods.
With regard to when the true impact of the crisis on direct lending will come, sources suspect it will play out over the coming quarters.
"Given the huge amounts of finance available to some companies, we won't necessarily see any signs of stress perhaps until the end of the calendar year, when those loan facilities … will start being repaid or employees come off furlough," said Peter Wallach, director of investments at the £8.9 billion Merseyside Pension Fund, Liverpool, England. "There's quite a lot of slack for companies in the short term. That will probably help direct lending to remain successful."
And weak covenants also have a part to play in pushing problems down the road.
"Given we're not going to see proper distress, you wouldn't think, until Q3 or Q4, that's the first time (the market) can start thinking about companies being in trouble. Given weak covenants, you could well add another six months to that," said Will Nicoll, CIO of private and alternative assets at M&G in London.
The feared outcome for Patrick Marshall, head of private debt and collateralized loan obligations at Federated Hermes Inc. in London, is a new class of companies in Europe.
"I can see a Japanification of European (small and medium enterprises) ... the rise of zombie SMEs, companies continuing to operate on either government liquidity support or because covenants are so loose there is nothing to trigger a default or a restructuring, and ultimately we will see far lower recoveries when the time absolutely comes to deal with this issue and there's no further escape route."
