First off, we at Securian Asset Management hope this finds you and your family healthy and safe. Several weeks ago, Securian Asset Management made the transition to working from home, as have many of our clients and counterparts. The shift has been relatively smooth despite new challenges, as several us look to balance our day job alongside homeschooling for the first time, amidst other adaptations.
Going into 2020, the overall private placement portfolio was strong, with diversification across borrower, geography and sector, and only a small number of credits on the Credit Review list. While our private placement portfolio is not immune to the current events, we take comfort in the Team’s disciplined approach to underwriting credit, focused on resilient business models, strong asset coverage and solid liquidity. A key focus of Securian Asset Management’s underwriting also includes the negotiation, and structuring, of covenant protections appropriate for the borrower.
Over the past several weeks, the Team has hosted numerous calls with portfolio company management teams as we look to assess the borrower level impact of COVID-19. Portfolio companies are focused on cash preservation and well positioned with strong liquidity to bridge the reduced economic activity due to COVID-19. With the unprecedented speed and breadth of COVID-19 on economic activity, our Credit Review list has grown, with recent additions related to first order of magnitude sectors (e.g. Aviation, Lodging, etc.). The Team is taking a conservative approach to credit designations and internal ratings, adding names to the Credit Review list as soon as there are concerns. As in past downturns, we expect that this list will continue to evolve as transparency around current events increases.
What has happened?
It has been our opinion over the past several years that the global economy has been in the late stages of an economic cycle, in addition to the challenges of trade wars, Brexit and increased corporate leverage. In response, the Team increased our selectivity, with an increased focus on structure, strong cash flow generation and asset intensive businesses models.
COVID-19’s impact on the global economy is unprecedented. With increasing probability, it appears that the COVID-19 pandemic will be the external event that ends the record U.S. economic expansion. The global response of social distancing is bringing large portions of the global economy to a standstill. Given the speed and severity of the economic disruption, few sectors are immune, with large portions of the global economy (individuals and corporate borrowers) requiring additional liquidity to bridge the gap. To date, this has been in the form of unprecedented fiscal stimulus, which will likely continue, and corporate drawdowns of revolvers. The ultimate impact of COVID-19 on the economy is unknown, given it is difficult to estimate the length and severity of the pandemic response and effectiveness of policy response.
Value of Covenants
If one looks at past data, approximately 50% of the excess return of private placements vs. public bonds is derived from covenants. Many of those reading this letter have heard the Team discuss the value of covenants through an economic cycle and we will very soon see the value of covenants come in to play.
As a reminder, the covenants in private placement transactions provide lenders an early seat at the table, reducing the downside risk and generating higher recoveries vs. a public unsecured bond portfolio. Covenant thresholds typically trip at BB/B credit profiles, protect our position in the capital structure and allow for the repricing of risk.
The Team’s primary goal in negotiating with borrowers is to preserve the value for our clients. In the case of companies directly impacted by COVID-19 (e.g. airports), covenant relief is necessary to help bridge this period of lower revenue. As of March 31st, 2020, we have received six material amendment requests for covenant relief, and we expect requests to accelerate as the impact of COVID-19 is experienced across corporate income statements. The increase in amendment activity is a sign that the covenants are working, generating value for our investors.
While the current events are unprecedented, this is not the Team’s first time going through an economic downturn. In addition to Securian’s 30+ year experience investing across several economic cycles, both the investment and legal team have relevant workout experience. Additionally, with the disruption in debt capital markets and widening of credit spreads, we expect to see the private placement yield premium increase from recent years. The additional yield, combined with strong structure protections, will generate attractive investment opportunities going forward.
Please do not hesitate to reach out with any questions during this time.
The Private Placement Team