Turning Crisis into Opportunity: Lessons from Liberation Day

Introduction

Warren Buffett's observation that “It's only when the tide goes out that you learn who's been swimming naked,” has proven particularly prescient in the aftermath of Liberation Day on 2 April. The ensuing market stress exposed clear differences between private credit managers, that offered important lessons for investors. It specifically highlighted two critical factors through which investors can evaluate direct lending manager: asset selection and portfolio management. Here we share four key lessons from Liberation Day.

#1 Sector selection matters

Tariffs hit multinational distributors and asset-heavy industrials particularly hard given their dependence on foreign sourcing and international trade. Prior to the Global Financial Crisis (GFC), these companies typically could not access cash flow lending due to their volatile cash flow profiles. The events that followed Liberation Day exposed a concerning pattern in the direct lending market that we also saw following the GFC. These sectors traditionally rely on asset-based and asset-backed loans to address their working capital requirements, significant capital expenditures, and sensitivity to commodity pricing. However, the flood of capital into upper middle market lending drove some general partners (GPs) to provide cash flow loans to these sectors – a departure from historical lending wisdom. The tariff announcement exposed a potential flaw in using cash-flow metrics to evaluate loans for asset-heavy industries.

Whether tariffs are here to stay and to what extent remains to be seen, but elevated raw material costs and supply chain disruptions appear entrenched now. Industries that are highly dependent on physical assets with high fixed costs and high switching costs (e.g., lending to commodity producers) face disproportionate risks in this environment, in our view.

#2 When it comes to size, one size does not fit all

Conventional wisdom might suggest that size equals safety. However, this notion has been challenged in recent years – and particularly during the tariff crisis. The loans of larger borrowers, despite their perceived stability, have recently seen a spike in lender-on-lender violence during liability management exercises (LMEs). This dynamic was partly due to overcrowding in the large-cap lending space, often resulting in a mismatch between the capital structure and the nature of the underlying business. In short, too much leverage for too little and too volatile cash flow. Further, larger borrowers saw greater exposure to tariffs compared to their middle-market counterparts, driven by their reliance on offshore supply chains, as well as international revenue sources.

In contrast, middle-market companies, typically less dependent on international trade, demonstrated greater resilience. Middle market lenders, which benefitted from a broader pool of borrower candidates and less capital concentration, have seen lower defaults in the past few years compared to the broadly syndicated loan (BSL) market, as well as virtually no LMEs owing to strong covenants.

#3 Informational advantage is alpha

The crisis also highlighted the critical importance of information access and portfolio management capabilities. Effective middle-market lenders gained an edge through information gathering, often securing monthly financial reporting from up to 70% of their portfolio companies. By contrast, the BSL market typically provides updates on a quarterly basis and rarely gives individual lenders access to management teams.

Middle-market lenders’ information advantage allows them to make more informed decisions more quickly during periods of market stress. A skilled direct lender can differentiate itself both by reporting frequency and by the quality of data they negotiate in bespoke credit agreements. In addition, prudent lenders can benefit from better access to borrower management teams and sponsors. The value of this access became evident during the tariff crisis – middle market lenders with direct relationships were in dialogue with management within 48 hours of the announcement.

#4 Insight needs to be transformed into action

Many private credit managers claim they actively manage their portfolios and have direct access to borrowers and sponsors – assertions that can be difficult to prove or to quantify into tangible investment advantages. However, during the tariff crisis, the best managers had quantifiable insights into their exposure to the revenue and supply chain impact of tariffs within days of the Liberation Day announcement.

As the situation continues to evolve, direct lenders with institutional-quality risk management processes and systems will be able to monitor their portfolios in real-time, adapting to rapidly changing conditions. This dynamic also delivered valuable insights for evaluating new deals and incorporating tariff impacts into portfolio construction decisions.

Conclusion

Real-time information access during the crisis revealed both the quality of underlying borrower management teams and the effectiveness of direct lending managers themselves. The best managers proved their worth through prompt scenario analyses and clear action plans. Following Liberation Day, top-tier managers delivered comprehensive analyses swiftly, distinguishing themselves from peers who were slower to respond or less rigorous in their analysis.

As former UK Prime Minister Winston Churchill observed, "A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty". Despite the challenges posed by the tariff crisis, particularly for managers with significant exposure to affected sectors, the situation has created compelling opportunities in direct lending for select managers to showcase their key differentiators. The current environment may offer attractive credit terms and higher yields, while the recent turbulence has provided investors with valuable insights for manager selection.

The crisis has served as a decisive test for direct lending managers, providing transparency into their investment processes. The most successful managers demonstrated prudent industry selection, strong information access, and superior portfolio management capabilities. These insights now provide investors with a practical framework for selecting direct lending partners, transforming recent market turbulence into a valuable tool for future investment decisions.