Despite Contraction, PE-backed Companies Could Weather Credit Strain
The economic impact of the coronavirus outbreak is expected to put significant strain on credit markets, but private equity-backed companies are in a strong position to endure a lending crunch.
The coronavirus outbreak struck the economy hard and fast. The pandemic’s economic impact is expected to be widespread and will put significant strain on credit markets, but private equity-backed companies are in a strong position to weather a potential lending crunch.
A person would have to go all the way back to 1958 to find the steepest drop in U.S. GDP in a single quarter—a contraction of about 10%. That record could be broken soon, according to Robert Dye, senior vice president and chief economist at Comerica Bank.
“We’re in a period of virtually unparalleled demand destruction,” Dye said during Monday’s virtual panel addressing the pandemic, hosted by the Association for Corporate Growth in partnership with its Los Angeles and Philadelphia chapters.
While the federal government has taken aggressive steps to combat the economic fallout of the coronavirus outbreak, including a $2 trillion aid package passed by the Senate on Wednesday, middle-market companies are trying to build up their cash reserves to weather the coming demand crunch.
“Headlines change every day. And with all this uncertainty, everyone just feels better having a little bit more cash beyond their balance sheets.”
Managing Director, Delancey Street Partners
Another panelist, Steven Higgins, managing director at investment bank Delancey Street Partners, said that some of his private equity clients have been encouraging their portfolio companies to draw down their credit lines. “Headlines change every day,” he said. “And with all this uncertainty, everyone just feels better having a little bit more cash beyond their balance sheets.”
But lenders may not be willing to extend that credit if uncertainty persists. “There’s some real key concerns about credit markets and valuing risks going forward,” Dye said.
If the risk becomes too high, there are fears that lenders may begin to break their covenants with portfolio companies. But Chris Miller, a partner at law firm Pepper Hamilton, is confident that financiers won’t pull back on their commitments—if only to throw borrowers a lifeline. “Lenders don’t want to be pulling back the capital right now,” he said.
Even if existing credit lines are secure, new financing opportunities are going to attract additional scrutiny. Despite lenders’ increased diligence, Delancey said it will be constructive.
He expects lenders will view this as a “sea change” for many businesses and try to find new ways to work with both companies and private equity firms.
Jeremy Holland, managing partner of private equity firm The Riverside Company, expects lenders to exercise some flexibility as the firm continues to invest. “We’ve been through crises before, and certainly this one is different, but we did learn from those prior events,” he said.
Holland said Riverside has closed on four deals in the last few weeks. “We’re open for business. Full stop,” he said, adding that private equity firms continue to operate with record amounts of dry powder and a willingness to put it to work.
Large companies are likely to weather the coming storm better than their midsize counterparts, simply because they have deeper pockets. But middle-market companies with a private equity backer could have an important advantage. Their managing teams can assess liquidity options and give confidence to lenders who might otherwise restrict their financing to privately held companies.
“We’re in a position that many family-owned businesses would not be,” Holland said. “[Lenders] can look at our track record over the last 30 years and that we plan to be here for the next 30 years.”
Benjamin Glick is ACG Global’s marketing and communications associate.