Asia distress: Band-aids for corpses

The sheer scale of COVID-19 as an economic event was quickly recognized as it moved from an internal Chinese problem to a global one. But recognizing and understanding are not the same thing.

Understanding, even with planetary themes, is best done at ground level. For many individual businesses, revenues have gone to zero for a prologued period of time. Strangely, for the private equity investors that target these businesses, such performances must be dismissed to some extent.

No downside protection scenario can reasonably contemplate a half a year of zero revenue. The only way to keep investing is to take a certain amount of faith in the recovery narratives being bandied about, which often involve a significant amount of leniency on the part of the landlords and banks providing companies with their lifelines as going concerns.

Indeed, there is a sense that, in many instances, banks cannot turn companies down for an extension on credit. This is not a crisis in an isolated sector. Every company has been impacted, in some cases near or beyond the point of default. Banks are owed so much money, they cannot afford to say no to extensions right now.

All parties are basically rolling their liabilities forward. Businesses will go into hibernation connected to systemic life-support machines on autopilot. Investors need only identify the ones that are most likely to be able to wake back up again swiftly when it all blows over.

Naturally, this stasis is being maintained by government, with the extent of the intervention varying by industry and jurisdiction. COVID-19 has cut loose a global avalanche of emergency fiscal and monetary policies to control the damage to businesses, including company-level lending.

As global credit and distress investor Värde Partners points out in a recent report, this may solve some liquidity problems, but it cannot address deep fundamental solvency. Investors will therefore need to evaluate the nuances of government intervention across various market-specific scenarios to accurately identify winners and losers at the company level.

“Saddled with large books of direct loans on relatively highly leveraged companies, many private lenders will struggle through an economic downturn of this magnitude,” Brad Bauer a partner and deputy CIO at Värde, said. “A lack of meaningful experience in restructurings and asset ownership combined with a limited secondary market for private debt, should result in a significant amount of forced selling at steep discounts and some extraordinary value destruction.”

The distress opportunity spelled out here offers an important warning, however, for investors looking to play similar themes with new ventures into private debt.

The trick here will be in calculating the significance of different kinds of government support with different kinds of companies in an operating environment with no real precedent across timeframes that cannot be estimated.  If an unprecedented show of state support fails to prevent an unprecedented wave in defaults, the private credit opportunity may not be as juicy as it appears, especially for newcomers to the asset class.

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• Topics
• Restructuring
• Restructuring
• Credit/Special Situations
• Asia
• Distress