When financial markets swoon, private equity pros are known for checking the debt side of the equation first as that determines their cost of leverage for deals.

Because the full effect of Covid-19, the disease caused by a novel coronavirus, remains unknown, the outlook for lending and M&A is far from clear in the wake of turmoil in the global financial system in recent days.

As in any market disruption, M&A prices may come down, equity payments in deals will go up, and Ebitda adjustments will draw more scrutiny, M&A lenders told The Deal.

While loans are still being issued, the severity of this new crisis and its impact on the economy remain unknown. This uncertainty will likely put a damper on M&A dealmaking in many sectors, if not across the board.

“Every day, and every hour, there’s new data you’re reacting to,” said David Brackett, CEO of Antares Capital LP, a large middle-market lender with more than $27 billion of assets under management.

Moody’s Investors Service Inc. analyst Mark Zandi said in a note on Monday, March 9, that Covid-19 is dimming the optimism of U.S. consumers. The response by the Trump administration and Congress will be critical to shore up confidence, but even with their support the economy may suffer a downturn.

Stock prices have slid by 10% to 15% from record levels in late February. About $5 trillion in stockholder wealth has been wiped out. If sustained, that loss of wealth may translate to $225 billion less in consumer spending in 2020, or about 1% of GDP.

“With the economy on track to grow by only around 2% even before the virus showed up, it is easy to see why recession risks are so high,” Zandi said.

For its part, Antares Capital is down 7% from year-ago in terms of new deals and down 16% trailing 12 months on a weekly basis.

But the real impact of coronavirus on deal flow hasn’t quite hit yet. The firm is still seeing new loan requests coming in as of Tuesday, March 10.

“We are still seeing opportunities coming in, but In terms of our pipeline, deals are getting pulled or delayed, which makes sense,” Brackett said. “People are trying to assess the impact.”

The deals being pulled are those that have a clear connection to the virus. Those would include companies in the financial services space tied to recent market disruptions. Businesses involving people gathering in groups are vulnerable. But all enterprises are impacted differently.

“Yesterday we talked about working on a couple of deals,” said Antares CEO Brackett. “One was in the financial services space, and the other was business services. The one in the financial services space doesn’t make sense to pursue aggressively, but it’s still one we’re going to watch. We’re not pencils down on it. The opportunity in the business services space seems very well insulated, so we’ll pursue that.”

Software appears to be another well insulated sector because it’s related to improving efficiencies and helping business productivity, he said.

Antares and other lenders are looking more carefully at the structure of deals. Is it the right amount of leverage? Is there a slowdown in the economy that needs to be accounted for? Are there terms around Ebitda add-backs, a place where the market has gotten more aggressive, now more difficult to achieve? Lenders may discount those adjustments nowadays, Brackett said.

Right now, pricing of debt in the secondary loan market is down, and that may impact the price of a loan and the price of a new deal that a lender is willing to finance, he said. A lender may therefore find it more attractive to buy a position in the secondary market in a credit they know well and have confidence in how it will perform in the new economic environment.

“All these factors may impact the price at which you’re prepared to do a deal,” Brackett said. “We’re a long-term buyer for these assets. I’m OK at pricing to what’s acceptable for our book. But when it comes to assessing the appetite of investors who may be more market sensitive, getting a market clearing price involves more guess work.”

Antares has 450 middle market credit borrowers in its book. It’s the lead agent on 80% of them. The firm has great visibility into their performance. Only 15% of its businesses have exposure to China and mostly just through sourcing products. The firm has a very defensive book to begin with.

“We went from thinking about very isolated supply disruptions with a transitory effect on a handful of companies, to now, based on market reactions, this could be what causes a broader downturn in the U.S. economy,” Brackett said. “The lens is changing, You have to have more focused conversations on the impact of a downturn on the business. That’s the credit conversation.”

Overall, risk levels in lending are going up.

“There’s still winners and losers and there will be credit available for the right deals,” Brackett said. “We’re open for business and looking to take on new opportunities. Clearly the lens is much more against a higher likelihood of an economic downturn.”

For its part, middle-market private lender Churchill Asset Management LLC has not seen much of a change in its activity.

“We’ve not seen any deal slowdown at this point,” said Randy Schwimmer, senior managing director and head of origination and capital markets at Churchill. “So far we’ve had a record quarter in terms of our investing activity. As this situation unfolds, you could see continued volatility in public markets. There’s always hesitation to launch new deals in a choppy environment.”

Churchill is keeping close watch on company performance relative to projections. It also avoids covenant lite loans, defined as credit facilities with fewer restrictions on the borrower and fewer protections for the lender. Churchill also continues to carefully analyze sponsors’ Ebitda projections, seen as a factor in inflating purchase price multiples.

“If they’re off-plan, we’re on the phone quickly with the sponsor to find out why and how they can get back on-plan,” Schwimmer said. “We’re fairly conservative how we structure debt financings, but you have to be alert to the nuances of creative Ebitda definitions.”

While it’s still early days in terms of the impact of the coronavirus on the loan market, Schwimmer said the focus will be on the travel, leisure and retail.

“Issuers and lenders will be attuned to how this global event plays out in terms of loss of production or inventory shortages,” he said. “And beyond travel and leisure, energy-related companies are now in the spotlight. The level of uncertainty in these sectors is high.”

On the plus side, private equity firms and lenders still hold plenty of dry powder. Deal-making pros are willing to work from home to get transactions done. It’s still possible to put an acquisition or sale process together, but it may get tougher to get management teams together in one room to sit down and work through processes.

“There are many reasons why things will tend to slow down and pause, to give people time to figure out where things are headed,” Antares’ Brackett said.

Similar dynamics in the broadly syndicated loan market have led to bids for loans falling to about 91 cents per dollar of debt from 97 cents at the start of the year, according to market gauges. The drop reflects emotion in broadly syndicated loans.

“We’re in a bit of a waiting period to see where prices will go and what’ll happen to the market, before people try to get deals done,” one market observer said.

Historically, private equity deal prices come down during times of distress, which gets reflected in the performance of private equity funds.

PE firms collectively saw their internal rate of returns (IRRs) on funds go from about 23% in 2007 to negative 26.3% in 2008, the year that Lehman Brothers collapsed, according to data from Preqin.

However, the asset class quickly bounced back with average IRRs of 10.5% in 2009 and 19.6% in 2010. In 2019, IRRs came in at 16.3%, according to Preqin.

Editor’s note: The original version of this article was published earlier on The Deal’s premium subscription website.