Private Capital Call

At recent private credit conferences we’ve been asked how managers think about portfolio construction. Kind of depends on your experience over the past twenty-two months.  

As one private equity partner told us, “we had a base case and a down-side case, but we didn’t have a no-revenue case.” Consumer-facing sectors had a rough time early on, particularly small retailers. B2B managed better, and in some cases, thrived.  

Today the Omicron variant threatens to reverse growth scenarios and capital markets globally. Too early to tell whether this strain will be worse than Delta, or like Mu, disappear without a ripple...

Thanksgiving week in the US capital markets is always a mixed blessing. Wonderful for families and friends, celebration and gratitude. But smack in the crazy year-end rush. Everyone juggling deals and parties – and running on fumes. Six weeks before it starts all over again.  

What will 2020 deal activity look like? Hard to beat 2021. As our friends at S&P LCD noted last week, high-yield bond and leveraged loan issuance set a new annual high of $1 trillion. And as our Chart of the Week depicts, combined syndicated and direct loans set a record $228 billion, topping 2007’s BSL-only mark...

As investment managers run through the tape towards an incredibly productive 2021, many are asking what will the new year bring?

No one could have foreseen a year ago vaccine success, or the 25% equities run-up. But we have have seen remarkable private credit performance over the past 24 months, so let’s highlight some key themes for the next twelve. 

Activity levels. 2021 was characterized by the unleashing of pent-up private credit demand from issuers and investors. A lot was attributable to the virtues of the asset class highlighted by Covid: relative yield, less correlation and lower defaults. Will these benefits weaken from competitive pressures?

Our friends at William Blair ended their 3Q survey with issues most impacting leveraged loans through year-end. Here are a few:  

Supply/demand equilibrium. Which comes first, supply or demand? Retail cash inflows and CLO capacity largely drive liquid loan demand. With private credit, it’s all about manager dry powder. There’s plenty of that.   

But as we’re experiencing this quarter, deal flow is swamping investment teams’ band-width. Managers can thus afford to pick and choose, which means terms should lean more investor-friendly...

Having moderated three private credit panels in the past ten days, a recurring theme we’ve heard is the record level of deal volume. What’s driving this unprecedented activity?  

In its recently published 3Q survey, William Blair reported $155 billion of institutional loans, nearly the highest number they’ve recorded. $92 billion was dedicated to M&A transactions.  

Covid tailwinds are boosting companies to historic highs on revenues and Ebitda, encouraging owners to cash out at relative valuation peaks.

We reported (in person!) this week from the SuperReturn Private Credit conference in Chicago, an event that always attracts top-shelf credit investors and managers.   

In a keynote interview with economist and former Federal Reserve governor, Randall Kroszner, we explored the contrast between two US economies: Covid-challenged, like restaurants, that are still in a recession, and Covid-assisted, like technology, that’s on a hiring tear. How can one monetary policy cover both?  

Dr. Kroszner agreed this is a fundamental challenge. He also cited a study in which differing state incentives in the Sioux City region resulted in the same employment outcomes...

News reached us recently of a young walrus that had wandered south from his Arctic range in search of ice floes. Landing in Ireland, Wally began boarding luxury yachts. The property damage turned the whiskered wayfarer from “visiting celebrity to public enemy number one.”  

It all worked out, though, when a marine biologist enticed the walrus onto a pontoon, which was hauled out of the harbor. Wally was last seen frolicking off the coast of Iceland. “He avoided sinking any boats while he was there,” one rescuer happily reported.   

In the world of low rates and an uncertain economy [Chart of the Week], credit investors are similarly tempted off their usual hunting grounds. As Nuveen’s Brian Nick highlighted recently there is a “lack of clear and consistent signals about the trajectory of the global economy and public policy.”...

Of the many unanticipated consequences of Covid, one catching our eye was the recent NYT headline: “Birds Thrived During Lockdowns.” Seems that while we were stuck at home last spring, our feathered friends were out partying.   

Urban areas, otherwise crowding out some species, saw hummingbirds and bald eagles return at 14 times pre-pandemic levels. “I am shocked at the fact we saw so many changes in bird behavior,” a Canadian conservation biologist reported. Pigeon populations were unchanged.   

Leverage finance has experienced similar post-Covid alterations of behavior. This week the broadly syndicated market set a record for annual issuance - $505 billion, according to S&P LCD. With the bulk of the fourth quarter to go, 2021 will easily surpass 2017’s record $503 billion...

Last fall, the Harvard Business Review examined Covid’s impact on supply chains. The pandemic, they wrote, “exposed vulnerabilities in the production strategies and supply chains of firms just about everywhere,”   

The study also presciently identified “the growing electronics content in modern vehicles” as a potential bottleneck. Today we are witnessing how the shortage of semiconductor chips is hampering auto production.   

Moving production in-house and increasing automation could help with uncertain labor and even social distancing. But consumers are demanding more choices, spawning a blizzard of SKUs. We love our Cheerios, but do we really need 23 varieties? (Including Pumpkin Spice, Limited Edition).

Even in normal times, private equity sponsors pay ruthless attention to cost structures of portfolio companies. Covid has raised to new levels the challenges buyers have managing supply chains. 

“Eighteen months ago, Covid was a top-line issue; now it’s mostly a cost issue,” one partner told us. “We can pass price increases along, but with  90-days notice. That’s too long to wait.”

Another source agreed. “We’ve been playing catch-up all year,” he said. “Revenues are fine, but costs are out of whack. And here we are a year later – we thought this would be fixed by now!”...