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Covid-linked debt rush ignites direct lending market

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Bombardier had always relied on its banks to raise large amounts of funding, but when the Canadian aircraft maker needed a $1bn loan at the height of the coronavirus crisis it turned elsewhere: to a private investment firm.

Medium-sized businesses have for years raised debt from so-called direct lenders, which often sit within larger private equity groups. But a rush of inflows from deep-pocketed investors such as Middle Eastern sovereign wealth funds is now giving some investment firms the firepower to lend to larger companies. The coronavirus crisis, which upended corporate balance sheets, has accelerated the shift, executives say.

Paulo Eapen, head of the European business at Blackstone’s GSO Capital Partners, said it was busier than ever. “We tend to be more active in periods of dislocation and I think we’ll be in a period of dislocation for a while.”

GSO is one of a handful of firms that can single-handedly write a $1bn cheque, a group that includes private equity firms — such as Apollo and Ares — and Bombardier’s lender HPS Investments, a specialist debt investor with $60bn in assets.

In a sign of how competition is hotting up for jumbo-sized deals, Apollo in July unveiled a new direct lending partnership with Abu Dhabi sovereign wealth fund Mubadala, which will expressly target $1bn deals, with the aim to deploy $12bn in just three years.

Mubadala also struck a similar but smaller partnership in September with asset manager Barings, targeting European companies. The investment arm of Credit Suisse, meanwhile, teamed up with the Qatar Investment Authority to launch what it called “a multibillion dollar direct private credit platform”.

Bar chart of Amount raised by direct lending funds ($bn) showing Money focused on direct lending is steadily growing

Large-scale loans are not new. Last year, Apollo backed the takeover of US newspaper business Gannett with a $1.8bn loan, at an eye-watering 11.5 per cent interest rate. 

But James Zelter, Apollo’s co-president and chief investment officer of credit, said that such large-scale lending opportunities had “only accelerated” since the onset of the pandemic.

“There is a challenging credit environment coming up and our view is that those companies will need different capital solutions,” he told the Financial Times.

Many of the firms at the forefront of the direct lending boom can trace their lineage back to Michael Milken, the creator of the modern-day junk bond market. Apollo’s co-founder Leon Black was a senior executive at Mr Milken’s Drexel Burnham Lambert in the 1980s, as was his brother-in-law Tony Ressler, who also co-founded Ares in 1997.

Since the buccaneering era of the 1980s junk-bond boom and bust, however, the now relatively staid high-yield bond market has grown past $1tn in the US, as has its close cousin leveraged loans. In both, investment banks underwrite debt for companies on highly standardised terms, before distributing it to hundreds of asset management companies.

Direct lenders, by contrast, act alone or in a small club. They can offer loans with unconventional features, such as delayed drawdowns, in a process conducted entirely away from the glare of public markets. This greater privacy and flexibility comes at a cost, meaning that large deals tend to stem from private equity-backed companies with a specific reason for eschewing public markets. 

Ares broke records for the largest ever private-lending deal in June, arranging a £1.9bn loan package for Ardonagh, a privately owned UK insurance broker that previously received a mixed reception in the high-yield bond market. 

Bombardier, founded 78 years ago, has been listed for decades and has billions of dollars of publicly traded bonds outstanding. Yet as it looked to plug a potential funding gap this summer, while awaiting regulatory approval to sell its €7.5bn train division, the manufacturing giant turned to HPS instead.

“We had to look at every element of their existing capital structure, all the various business divisions and process all that complexity to come up with a deal everyone was happy with,” said Mike Patterson, a managing director at HPS.

Bombardier said it had “extensively considered several different financing options” and ultimately decided on a private deal “because it provides more flexibility at a competitive cost”. HPS underwrote the full $1bn commitment in July, before later bringing in Apollo and Ares.

Even more big-cheque deals could have arisen, executives say, were it not for the market-calming measures enacted by the US Federal Reserve to buy corporate bonds and slash interest rates. That enabled troubled borrowers such as cruise operator Carnival to raise money in the bond market instead.

“I think everyone was a bit surprised at how quickly the rally took away some of those larger capital opportunities,” said Kipp deVeer, head of credit at Ares Management.

But medium-sized businesses, which Mr deVeer said have “less flexibility in the public, liquid credit markets”, still offer significant opportunities, he added.



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Analysis

Has Venezuela’s economy bottomed out?

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After one of the biggest economic meltdowns in Latin American history, there are signs that Venezuela may finally be turning a corner.

According to some economists, the socialist government’s decisions to loosen currency controls, relax import restrictions and encourage informal dollarisation have breathed a modicum of life into an economy that has shrunk by about 75 per cent since 2013.

The change of government in the White House has also raised hopes that a solution might be found to the country’s long-running political stalemate, which might lead to an easing of US sanctions and in turn fuel a further rebound.

Credit Suisse recently predicted the Venezuelan economy would expand by 4 per cent this year, which would be its first year of growth since 2013. The bank acknowledged this was in part due to the resumption of economic activity after last year’s hit from the coronavirus pandemic, but this was “not the whole story”.

“The revival in domestic demand, which we have long been noting, is becoming more apparent in the data,” Alberto Rojas, the bank’s chief economist for Venezuela, wrote in a note to clients.

“The easing of controls and widespread use of foreign currencies in everyday transactions has rekindled economic activity — even if just slightly.”

Rojas forecasts further growth of 3 per cent in 2022. “In our view, the growth this year is not just a dead cat bounce,” he wrote.

In Caracas, people were sceptical that this amounted to any sort of meaningful recovery. According to the IMF, per capita gross domestic product in Venezuela has dropped a staggering 87 per cent over the past decade, from $12,200 a year in 2011 to $1,540 now. For the first time, the average Venezuelan is poorer than the average Haitian.

“When you’ve fallen so low, eventually you’re bound to see some sort of correction,” said Adán Celis, president of Venezuela’s manufacturers’ association Conindustria. “The government has introduced some anarchic measures of economic flexibility and that’s provided us with a little bit of oxygen but the structural problems remain.”

But a handful of other banks and consultancies also expect output to increase. Two Venezuelan consultancies, AGPV and Dinámica Venezuela, predict growth this year of 1.9 per cent and 2.3 per cent respectively.

UK-based Oxford Economics forecasts growth of 0.2 per cent this year followed by a jump of 13.1 per cent next year, although it stresses this recovery needs to be seen in context.

“This follows two years in a row [2019 and 2020] when GDP fell by a third or more,” said Marcos Casarin, OE’s chief Latin American economist. “Given the magnitude of the collapse seen since 2014, Venezuela could grow at double-digit rates for several years in a row and still not recover its pre-crisis GDP level.”

Column chart of GDP change (%) showing Venezuela's economy has been shrinking for years

For every economist predicting growth, there are plenty who say Venezuela will suffer more pain before things finally improve.

FocusEconomics, a provider of economic consensus forecasts, recently polled 21 banks and consultancies for their views on Venezuela. The consensus was for a fall in GDP of 3.1 per cent this year followed by a rebound of 2.7 per cent next year. The IMF predicts a contraction of 10 per cent this year and 5 per cent next.

The huge differences between forecasts reflect uncertainty over the consequences of the pandemic, the impact and timing of the rollout of Covid-19 vaccines and the future of the sanctions regime.

“The evolution of US sanctions under the Biden administration remains the key determinant of the outlook,” wrote Stephen Vogado, economist at FocusEconomics.

The sanctions prohibit Venezuela from selling oil to the US and make it difficult for it to export elsewhere, although the government has found ways to get round the measures. Venezuela’s oil exports have risen slightly in each of the past five months, hitting a 10-month high in March — although they are still feeble compared with historical highs.

While oil has been the mainstay of the Venezuelan economy for the past century, the country also used to produce cacao, coffee and rice in significant quantities. It boasted a textile industry and produced chemicals, cement, steel and aluminium. Most of those industries have been decimated in the past two decades of revolutionary socialist rule.

At an outlet selling car accessories in a petrol station in the Las Mercedes neighbourhood of Caracas, store manager Alfredo Barrera said informal dollarisation had brought some degree of price stability after years of hyperinflation.

“The economy has adapted to the country’s problems,” he said. “Right now, it’s fair to talk about relative stability in terms of the currency but we’re a long way from seeing real improvement.”

At La Alicantina, a bakery that has been in business for more than 30 years, manager Douglas Palencia said sales had been hit hard by the pandemic. The shop’s windows, usually full of cakes and pastries, were empty. “I don’t have great expectations for this year,” he said.



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Sturgeon taps Scottish resentment over Johnson and Brexit

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Kenny Paton, the postman in Dumbarton, has been criss-crossing the west coast town near Glasgow, delivering flyers for all the parties contesting Scotland’s parliamentary elections this Thursday. But he is only listening to one.

For all the shortcomings of the Scottish National party’s 14 years in power, the recent turmoil surrounding its handling of sexual harassment claims against former leader Alex Salmond and the destructive nature of its cherished goal of breaking the 314 year union, the party is on course for victory once again.

That is in large part because the SNP, with first minister Nicola Sturgeon at its helm, has been speaking to the heart, tapping into the deep resentment many Scottish people feel at being ruled from Westminster by Conservatives whose leader Boris Johnson and policies, notably Brexit, they did not vote for.

Dumbarton, Scotland map

For some Scots, the economic arguments against independence — and these have only grown with the sharp deterioration in Scotland’s fiscal position since Brexit and the onset of the coronavirus pandemic — are no longer cutting through. 

“You can get into all the intricacies about the border and the currency but at the end of the day who do you want to run the country Boris Johnson or Nicola Sturgeon?” said Paton, who once supported Labour, but is now rooting for the SNP.

Nicola Sturgeon campaigns in Dumbarton © Jeff J Mitchell/AFP/Getty Images

If opinion polls in the run-up to Thursday’s vote are correct, the party is sure to remain the largest in the devolved Holyrood parliament and will possibly gain the slender majority it wants to continue pressing Westminster, for its second chance in seven years of winning independence in a referendum.

There is also the probability that with the Scottish Green party, and Salmond’s newly launched Alba party, the SNP will form part of a bigger block in favour of Scotland going its own way.

Chart tracking voting intention polls for the constituency vote in the Scottish Parliament election

But to get across the line to an SNP majority, Sturgeon may need to win marginals such as Dumbarton, where Jackie Baillie, the deputy leader of Scottish Labour and a popular constituency MSP is defending a majority of just 109, the most vulnerable in Scotland.

As well as her appeal to Scottish identity, Sturgeon has a number of other things in her favour. One is Labour’s weakness, and the perception that it could be long before the party Scotland once voted for en masse returns to power.

“I have been an advocate for Scottish independence since the Conservatives won a majority in Westminster. They do not reflect our views — Scotland is a progressive place,” said Ross Crawford, a 28-year-old IT consultant. “It will be a while before Labour can collect themselves — that’s what makes it so discouraging. It means yet more Conservative rule,” he said.

Labour’s Jackie Baillie in Dumbarton © Jeremy Sutton-Hibbert/FT

Most of all Sturgeon has Brexit and the indifference shown by first Theresa May, the former prime minister, and then Johnson to the majority in Scotland who voted to remain in the EU and who wanted to retain close relations.

“In 2019, the polls began consistently showing higher levels of support for the SNP. The rise occurs entirely among Remain voters,” said John Curtice, professor of politics at the University of Strathclyde. “Whatever the preferences of Boris Johnson, and Michael Gove [Cabinet Office minister], the brutal reality is that their pursuit of Brexit has undermined support for the union,” he said. 

Julie Reece: ‘We felt safe with her [Nicola Sturgeon] during Covid’ © Jeremy Sutton-Hibbert/FT

For most of last year backing for independence in Scotland polled at 50 per cent or higher when undecided voters are excluded. But while it has slipped back since then, support for Sturgeon in Dumbarton remains high. This has much to do with her more assured performance during the pandemic, which has helped the SNP avoid an awkward reckoning for its less than stellar longer term record in areas such as education and health. 

“We felt safe with her during Covid,” said Julie Reece, a bus company manager and former Labour supporter now backing the SNP.

Like many people strawpolled in the constituency, Reece was unfazed by Sturgeon’s alleged mishandling of sexual harassment claims against her former ally. “They have tried to make her a scapegoat for Alex Salmond’s affairs,” she said, adding, with a nod to how the first minister has brought women like her behind the SNP cause: “She has engaged women better — it switches you on that bit more,” she said.

But the stakes are high and the tightness of the contest is also galvanising Scots who support the union and are passionately against the rupture it would cause. This has led to unlikely alliances in Dumbarton, with some staunch supporters of the Conservative party even promising to vote tactically for Labour — a rare occurrence in UK politics.

Chart tracking voting intention polls for the regional vote in the Scottish Parliament election

“Anything that keeps the SNP out,” said Carl Vickers, who works at the Faslane naval base further up the Clyde estuary, where thousands of jobs could be lost if Scotland breaks away. The SNP opposes the use of Faslane to store the UK’s nuclear deterrent.

Vickers described himself as a Conservative by nature but said he would be voting for Baillie on the day.

“It’s all about stopping them [the SNP] getting another referendum,” said Trish Collins, a headhunter and Tory who was also planning to vote for the Labour candidate in the constituency vote, which the Conservatives have little chance of winning.

In Scotland, members of the parliament in Edinburgh are elected using a hybrid voting system: constituency representatives elected using the first past the post voting system while additional representatives are elected according to the proportion of votes a party secures in a region comprising several constituencies.

On the banks of the river Leven, Baillie herself remained defiant. “My seat on paper should go to the SNP but I am a seasoned campaigner so I am not stopping until polls are closed,” she said.

A pro-Scottish independence rally in Glasgow last Saturday © Jeremy Sutton-Hibbert/FT

“Our number one priority should be recovery and then we can argue about the constitution,” she added, warning that when Westminster pulls the plug on the job protection scheme, there could be a surge in unemployment.

“Brexit has been a mess,” said Baillie. “Leaving the UK could be 10 times worse.” 

That need to focus on recovering from the pandemic — the core of Labour’s campaign — does appear to have resonance, even among some SNP supporters. But for those already convinced about the risks involved in breaking up the UK union, the feelings were even more emphatic.

“We’d just got over one independence vote then Brexit was thrown at us. Now the SNP have got a good chance of coming out with a majority — the whole of Scottish politics is a joke,” said Bryan Burn, a wholesaler for fishing tackle.

He was speaking an hour south by car from Dumbarton in the relatively prosperous town of Ayr, where Conservative MSP and former farmer John Scott is defending another slender majority. A life-long Labour supporter, Burn was visibly distressed at the way things are headed. “If I were younger I would be looking to move elsewhere,” he said.

But Sturgeon is picking up votes in Ayr too.

“I like what she stands for. She’s great at what she does,” said Chris Hughes, a self-employed software engineer, who hoped an independent Scotland could rejoin Europe, and who along with his wife was voting SNP.

Scott, the Conservative incumbent who is defending a majority of just 700 votes, acknowledged that the odds were even. “It will be very, very close,” he said. “The independence issue has become an issue of the heart. Many people don’t take into account the grim realities it might hold for Scotland.”



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Berkshire succession: Greg Abel confirmed as Warren Buffett’s heir apparent

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It was a pause just long enough for the astute Berkshire Hathaway investor to notice. Charlie Munger and Warren Buffett were sparring over whether Berkshire — the $631bn conglomerate they oversee — could ever be too large to manage.

“Greg will keep the culture,” said Munger, the 97-year-old vice-chair. The observation, which made Buffett briefly miss a beat, was interpreted by those listening as a rare signal about who would succeed him.

Greg Abel is Berkshire’s 58-year-old vice-chair and CNBC confirmed on Monday that Munger’s hint was indeed a nod that Abel is next in line. “The directors are in agreement that if something were to happen to me tonight, it would be Greg who’d take over tomorrow morning,” Buffett was quoted as saying.

Abel shepherds the company’s non-insurance investments, including the Burlington Northern Railroad, manufacturing businesses, and utilities he once ran as chief executive. He had been one of the two men most frequently tipped to one day take over from Buffett, alongside his other top lieutenant Ajit Jain.

It was already known that a succession plan had been drawn up by the board, but the heir apparent had been kept from the wider world. It was a secret that had captivated Berkshire shareholders for at least a decade given Munger and Buffett’s ages. Buffett will celebrate his 91st birthday this August.

On Saturday, investors were given their closest look yet at Abel and Jain.

On stage, the pair sat side-by-side with Buffett and Munger at the year’s annual meeting, taking questions and defending their strategies. Abel spent much of his time making the case for Berkshire’s renewable energy investments and why the company did not need to adopt a shareholder proposal that would require it to report on measures its companies are taking on climate change.

Ed Walczak, a portfolio manager at Vontobel, was among the investors who noticed the comment by Munger, which came late in the day’s three-and-a-half hours of questions. He said it was interesting that the response surfaced when neither Munger nor Buffett had been asked directly about who would take over.

“The good news with Greg was he had the answers on his tongue. There was no question or ambiguity in his responses,” he said. “Let’s hope Charlie is right that the culture can be replicated.”

Abel played a more high-profile role on Saturday, after a rather subdued showing the previous year when he joined Buffett at a sombre annual meeting and played a supporting role to his boss. This year he offered his thoughts on the inflation pressures affecting Berkshire, the takeover battle for rival rail operator Kansas City Southern, as well as how he spends his days at work.

Greg Abel footage on laptop screens
Greg Abel is one of the two men most frequently tipped to take over from nonagenarian Warren Buffett © Bloomberg

“I’m trying to understand what our competitors are doing, what’s the fundamental risks around those businesses, how they’re going to get disrupted,” he said. “It always comes back to are we allocating our capital properly in those businesses relative to the risk?”

James Shanahan, an analyst at Edward Jones, said Abel came across as a “very capable” executive and that the meeting benefited from both his and Jain’s presence. The pair offered insight into one area where investors have complained they are slightly starved of information: how the company’s underlying operating businesses are performing.

Given the “Berkshire playbook, which does not have an active investor relations function, Greg’s sharing of information and transparency was a welcome change”, said Cathy Seifert, an analyst who covers the company at CFRA Research.

Abel and Jain were promoted in 2018 to vice-chairs of the company, cementing their status as frontrunners for the chief executive role and making them among the most visible Berkshire executives alongside Todd Combs and Ted Weschler, who help manage Berkshire’s investment portfolio. Buffett said at the time that the promotions were “part of a movement towards succession”.

But Buffett’s succession plan has drawn fire from some big shareholders. BlackRock this year voted against Walter Scott, head of the board’s governance committee, citing “limited disclosure on succession planning,” among other things. Buffett’s outsized leadership role at Berkshire makes the succession risk even greater, BlackRock said.

“There is this parlour game about succession,” Seifert said. “From Berkshire’s perspective the succession issue has been resolved and to paraphrase . . . they’ve got Greg.”

Abel will face challenges when he inherits Berkshire, even if the company is not immediately in flux. Buffett plans to donate the vast majority of his wealth, which is primarily held in shares of Berkshire Hathaway’s class-A stock. As those shares are converted to class-B and sold on to new investors, the group may face more pressure from its shareholders and potentially draw scrutiny from an activist, Seifert said.

Buffett himself has conceded this point. In 2019 he said “there are no perpetuities” and Berkshire “needs to deserve to be continued in its present form”.

Pressure is already building. Investors this year have increasingly voiced frustration with Berkshire’s efforts on climate change. A shareholder proposal on climate change disclosures garnered about 25 per cent of the votes cast, a figure that belies the widespread investor support for the group to adopt the measures. Buffett’s class-A stock has 10,000 times the voting power of the class-B common stock that is more widely held by the general public.

Big holders of that class-B stock, including BlackRock and Norges Bank, voted in favour of the proposal.

“Remaining shareholders that voted in support of the resolution sent the company a strong message about the importance of acknowledging climate risk,” said Dan Bakal, a director at Ceres, a sustainable investor network.

Shanahan added that Buffett’s stake distorted the outcome of the vote, but that over time the shift by the shareholder base would leave a mark on the company. “I think that he kicked the can down the road, but it’s inevitable that investors and other stakeholders will demand disclosure about progress.”

Buffett spent part of Saturday defending how he had steered the company through the crisis and justifying why the Berkshire board advised stockholders to vote against two shareholder proposals. In characteristic fashion, he also joked about the two nonagenarians at the top.

“People talk about the ageing management at Berkshire,” he said. “I always assume they’re talking about Charlie, when they say that. But I would like to point out that in three more years [when Munger turns 100], Charlie will be ageing at 1 per cent a year. No one is ageing less than Charlie.”

Additional reporting by Patrick Temple-West

eric.platt@ft.com



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