The private equity industry’s resilience is tested due to the COVID-19 crisis. Though it has taken a toll on the economy, the outlook may not seem as gloomy as it portrays. Market volatility has led to huge losses, but it also has the potential to revive opportunities.
The 2007 and 2009 financial crisis took quite a toll on the economy. It was said to be one of the worst economic crises the U.S. had seen since the Great Depression. Unemployment grew at a steady pace, the stock market plummeted, banks tied up in regulatory knots – leading to a major downfall in the economy.
However, private equity firms were lucky enough to stand as an exception.
The funds that were deployed during the crisis in 2007-2009 ended up yielding 18 percent median annualized returns. Not to mention, investors from university endowments to the public pension funds surrendered cash inflow to the private equity managers. All in all, some of the largest PE firms made headways in property and credit markets, financial conglomerates that are straddling buy-outs along with the roles the Wall Street banks.
How some of the best private equity firms are dealing with the economic crisis?
Around 8000 firms that functioned under the PE in the U.S. are now accountable for 5 percent of its GDP growth. Assets under management have accelerated to over USD4trn.
Begin by analyzing the losses
PE firms have started reviewing existing investments and are now considering new opportunities during the sudden economic disruption.
The first quarter in 2020 noticed that private equity firms like Blackstone, Carlyle, and KKR, and Apollo reported an amount of USD 90 billion paper losses on their portfolios. Though the figure seems huge, it only cost 7 percent of their assets under management. This reflected how they could control their private assets and at the same time value their decisions in investment.
After the sudden fright caused due to the pandemic, the private equity firms shareholders concluded that the outlook may not be so dull as it seems. But, is their prediction moving in the right direction? You will notice that many PE managers have activated returns by piling it to the companies they have purchased. After the last crisis took place, multiple buy-out deals were made with a debt that was worth six-fold gross operating profits.
According to Bain & Company in the year 2019, they had three-quarters of deals that were leveraged for over six times, this indicated that the PE firms were equally vulnerable.
Over 50 percent of the 18-defaulted junk-rated firms during their first quarter were stated to be PE-owned says Moody’s, a rating agency. It is also expected the default rate of the overall junk firms will triple the amount to 14 percent by 2021.
Then and now: What has changed?
The past decade showed a transition from distracted and dopey banks into organized private-credit firms. Besides the crisis, private equity investment professionals have taken this as an opportunity to rethink and reset. However, several factors may have taken PE’s favor. The debts that were given to back PE deals have started enduring a big slump in profits without even triggering the lenders. Ever since the crisis that happened in 2007 – 2009, most of the PE managers started a set up for huge credit arms for large PE firms, therefore, this is now accountable as a third of their assets. Doing so can enable managers to give in in-house training and expertise for raising debts. Thus, making it feasible to restructure debts of all fragile companies based on terms that are feasible for both the parties.
However, if PE firms aren’t capable of raising debts, they can opt for an “equity cure.”