June 3, 2020
“Be fearful when others are greedy and be greedy when others are fearful.” – Warren Buffett, Annual letter to Berkshire Hathaway Investors
Leon Black might be the patron saint of private lenders. As analysts have scrambled to assess the damage wrought by months of lockdowns across the world, the leader of the world’s largest private lender was on hand to bring a positive spin to proceedings. In a call with investors at the end of March, Mr. Black called the coronavirus pandemic, “a time to shine.”
Mr. Black knows this is a time of great opportunity, he has been here before. We all have. Historical financial crises show us that the world emerges from crises with more debt, not less. This was as true for the Global Financial Crisis as it was for Savings and Loan Crisis nearly 30 years before it. It would be folly to believe that the post-COVID19 world will be any different.
Market dislocation not market destruction
Lessons can be learned from the GFC. The post-coronavirus environment will have similarities to the post-GFC environment, but it won’t be identical. This time, banks’ balance sheets are in much better shape and instead, it may be private lenders that hit the wall. Many of the small private lenders that have grown using leverage lines or buying agreements with hedge funds for their loans are in for a very rude awakening. As margin calls begin and leverage lines go away, these small lenders will be forced to adapt or disappear.
Their exit will create openings in private credit for others which have been waiting for a moment like this. Just like Leon Black, many private investors view a crisis like this as a time to play shark in an ocean full of fish. As the head of mergers at one Wall Street bank said recently: “they have been waiting for this type of market dislocation.”
A goldmine in the wreckage
For a six- to twelve-month window, there is likely to be a wealth of opportunities for investors and dealmakers with the resources – and the stomach – to capitalize on them. Those investors with ‘dry powder’ which has been building up over the past decade will now find significantly better terms than was possible just a few months before.
The big opportunity in the short-term is liquidity. The current regulatory structure prohibits banks from extending too much liquidity to small businesses. Even in those cases where they have the capacity to extend some credit, banking resources are stretched by an historic spike in PPP applications. These borrowers will continue to look to the private markets to fill the gap. As David Soloman said on a Goldman Sachs podcast recently “everyone in the private lending space, just became a bridge lender”, speaking to the fact that those in credit will need to to readjust expectations for the next year or so.
But bridge loans are just the beginning. Most industries’ dynamics won’t return to normal until consumer behavior and the supply chain in those industries readjust. Each industry and geography is different and the goldmine in the wreckage for private lenders is understanding which make the strongest recovery.
The time to shine
At some stage in every crisis, there is an expert who announces, “we’re never going back to the way it was.” There are currently books gathering dust on bookshelves across the United States penned in the past two decades with ambitious titles such as ‘The End of Oil,’ ‘The End of Food,’ and ‘The End of Banking.’ It turns out that the demise of all three was greatly exaggerated.
In business terms, coronavirus will only hasten the end of businesses that would have been the casualties of just about any economic downturn. In general terms, it doesn’t mark the end of anything. It is a phase. The most adept private lenders will recognize this and stand to generate massive rewards from understanding this phase better than others.