When Things Don’t Go as Planned

Michele Kovatchis
Every single deal is different. Every single deal is unique.

Rebecca Darst
What differentiates managers who avoid principal loss in workout situations?

Michele Kovatchis
You have to have the expertise to understand what can get done, what can't get done, what's important, what's not important. This highly involved adaptive approach sets us apart.

Rebecca Darst
In times of stress, dedicated in-house workout expertise shapes investment outcomes. For an expert practitioner's guide to the ins and outs of the workout process, I'm joined here by Michele Kovatchis, who heads up the Credit Advisory team at Antares and has more than 30 years of experience guiding corporate lenders and borrowers through the workout process. Michelle, this is going to be a meaty conversation, so let's get into it.

Michele Kovatchis
Looking forward to it, Rebecca.

Rebecca Darst
When a borrower is facing cash flow troubles, working directly with a small group of lenders is touted as a key advantage of the private market. So, what's your philosophy when beginning the workout process with a borrower.

Michele Kovatchis
Well, definitely having a smaller group of lenders makes for a much better process overall from a workout perspective. Our philosophy is to work closely both with the sponsor, the borrower and the management team, and the other lenders in the group to come up with a solution that will ultimately provide the runway and the flexibility for that borrower to be able to return to profitability in as quick a period of time as we can. Middle market companies tend to have really straightforward structures. Those type of structures are much less complex, much more transparent. For us, being in the middle market, we think the borrowers are better situated to be resilient to the various factors that are happening in the capital structures we think protect us from that perspective as well.

Rebecca Darst
How does this differ from what would be the case in the large syndicated market?

Michele Kovatchis
First lien lenders, we can't afford to even take a dollar of loss. If you have 50, 100 different lenders with all different agendas, it's very hard to come up with a creative solution that provides the flexibility that our sponsors and borrowers are looking for. In the large syndicated market, we typically find that they're more likely to end up in bankruptcy, which is not a good outcome for anyone involved. Whereas in the middle market, we have the ability, as we talked about, to really craft solutions that meet the objectives of all the parties involved and give everyone the best chance to maximize their outcome.

Rebecca Darst
Let's take a step back and describe for our viewers how the workout team that you've assembled here at Antares is put together.

Michele Kovatchis
Sure. We have probably the most experienced workout team in the business. We've been doing this for over 30 years, and then I have a team of six very seasoned, senior level individuals that have all been with the team for 15 to 20 years. Plus, then we have another 12 individuals on the team that support and backfill based on our portfolio and what's going on. So that team is a very experienced group. The other thing that's interesting about the construction of our workout team, we use it very flexibly also as a training tool. So, we'll bring in credit professionals, underwriting professionals, individuals throughout our credit business, we’ll bring them in for two, three, four years, get them the workout experience and then embed them back in the business. This makes for much better underwriters and originators and account managers throughout our business. This highly involved, adaptive approach is what sets us apart and helps us to get better outcomes for ourselves, our investors, and for our clients.

Rebecca Darst
In your view, what is the most critical component that differentiates managers who are consistently able to avoid principal loss in workout situations?

Michele Kovatchis
Every single deal is different. Every single deal is unique. There's really not a market for workout. On the front end of deals, you're really dictating by the market, but on the workout side, it really is different. You have to have the expertise to understand what can get done, what can't get done, what's important, what's not important, as these companies go through the various stages of transformation and recovery.

Rebecca Darst
So aside from reviewing the standard quarterly financial reports, are there any other leading indicators that you use to identify potential sources of stress early on?

Michele Kovatchis
There are some other leading indicators. The key things that we really focus on are: number one liquidity – so we're going to be very focused on cash levels and how those are changing versus the company's forecast as well as revolver utilization. We'll also look and focus on EBITDA addbacks. Over the last few years, EBITDA adjustments have gotten much more aggressive in terms of what's allowed in the market and in credit documents. So we're going to spend a lot of time really focused on what the true cash generating EBITDA is versus adjusted EBITDA levels. So, we'll use those to help us figure out what's going on and hopefully be able to be to the table much earlier, because we see things happening in those sort of leading indicators. We'll also look at the borrower KPIs. We're going to look at those key metrics and figure out how are they performing versus where they're supposed to be performing according to their plans, as well as we're going to look across our portfolio, where we have a number of peers for each of our borrowers. We can then have informed conversations, both with the sponsor and the management team about what's happening, why it's happening, and how we make changes to the extent those are necessary.

Rebecca Darst
So, to what extent does a direct lender's ability to avoid losses come down to the ability to negotiate stronger covenants at the outset?

Michele Kovatchis
Covenants are one tool in our minds. They're not the only tool. Covenants certainly can get you to the table, but because of our strong relationships with our private equity sponsors that we've worked with for 10, 20, 30 years in most cases, we think we get there earlier than even a covenant being tripped. The other thing I would say is, even in those situations where covenants may be a little looser, once a company is not performing, we think a lot of that flexibility should be at least temporarily removed. And then once that company is performing again, we can give them back that flexibility.

Rebecca Darst
So, walk our viewers through the timeline of a theoretical workout situation.

Michele Kovatchis
During COVID, we only had one situation where a sponsor wasn't prepared to support their business on an acceptable basis to the lending group. This was a company that was in the travel space. So, as you can imagine, during COVID it was dramatically impacted going from a very well performing business to one that was going to be a negative EBITDA business pretty much overnight. We worked with the sponsor and we took over, so we had to put in independent directors. We had to work with the management team on a new management incentive plan so that their interests would be aligned with those of the bank group. All the different things that needed to happen to keep this business alive during that uncertain period. This was a business that ended up recovering. It took us about three, three and a half years, but we got to the point where the business was back to performing at the level it was pre-COVID, put it on the market, we were able to sell it in early 2024, received back all of our debt, all of our interest plus equity upside, even though we never put in equity. So yes, we had to support the business, but at the end of the day, that flexibility, that creativity, we were able to bring that all together to a great outcome.

Rebecca Darst
Finally, if you could point financial advisors and their clients to one trait that reveals a private credit manager's ability to avoid losses, what would that be?

Michele Kovatchis
It's having the right resources in place. Having that dedicated workout team versus a number of folks will try and just drop in. That's not the way to maximize the outcome. If I were looking for the right asset manager, especially going into the economic period that we're going to face over the next few years, I'd be looking at ones that have those type of resources that have supported those type of resources year in and year out, despite what's going on in in the overall market. We do think it's important to work with managers who have these workout capabilities. You need to have managers that not only know how to do a straightforward amendment but also need to be able to do really material restructures of these businesses. If we do get to that point where the sponsor can't or won't support their business, we need to be able to step in. So having a fully resourced team like we do, where we can go in and step in as both owner and lender is absolutely critical.

Rebecca Darst
You said it. The wisdom of the workout team. Michele Kovatchis, thank you for speaking with me today.

Michele Kovatchis
Thank you, Rebecca.