What are the biggest challenges and opportunities [in debt investing] right now?

Biggest challenge:

We continue to witness the after effects of sharp sell offs in public markets, heightened volatility across multiple asset classes and a seemingly unending negative feedback loop between financial markets and the real economy. Lenders, including those in the fund financing space, appear to be making concerted efforts to conserve liquidity by restricting the availability of their balance sheets in financing transactions. The long-standing (and understandable) tendency amongst lenders to slow down the pace of lending in periods of stress in financial markets appears to have been exacerbated this time round by the unusual sight of vast swathes of the economy having been forcibly shut down to help deal with the Coronavirus pandemic. The consequent impact on future earnings of companies and on their valuations is still unknown and it is possible that reliable valuation data may not be available until well into Q3 of this year. This makes it difficult for lenders to reliably calculate the ‘V’ in LTV ratios, and fears of a substantial erosion in equity cushions is likely to put a dampener on lending to both Private Equity and Private Debt funds, both for new deals and in refinancing facilities that may be coming up to maturity. The drop in funding will probably coincide with the emergence of liquidity challenges in individual portfolios, and with a desire on the part of portfolio managers to take advantage of buying opportunities that are almost certain to present themselves in the coming months.

Biggest opportunity:

This period of heightened market stress will reinforce amongst borrowers the benefits of diversifying their lender base with respect to meeting their fund financing needs. Specifically, the attractiveness of sourcing liquidity from non-bank lenders such as specialty finance companies/funds and institutional investors such as insurance companies and pension funds is likely to become more evident. Specialty finance companies that operate in the niche space of providing fund level financing in concentrated NAV transactions are likely to see a higher level of interest as sponsors recognize the flexibility provided by fund level financing solutions in dealing with financing challenges around individual portfolio holdings. Institutional investors such as insurance companies and pension funds have a materially longer funding time horizon and the ability to offer highly bespoke covenant structures in fund financing transactions as compared to traditional bank lenders. Consequently, they are better positioned to help borrowers deal with the detrimental effects of the withdrawal of liquidity precipitated by the (seemingly) correlated actions of traditional lenders.