INVESTMENT banks are struggling to clear a backlog of debt they lent to companies and private equity to fund last year’s mergers and acquisitions boom.

Private equity takeovers, which rely on the use of debt, have returned to the centre of the turmoil in credit markets, most recently with the $6.5bn buyout of Solera, a US software company.

To fund these deals banks make so-called bridge loans for a short period, which are replaced by long-term debt such as junk bonds or syndicated leveraged loans.

Banks risk being left with losses if these bridge loans are ‘hung’ and they are unable to sell the longer-term debt at a price they promised to the company.


Banks risk being left with losses if these bridge loans are ‘hung’ and they are unable to sell the longer-term debt at a price they promised to the company


Last Monday Goldman Sachs elected to remove the euro-denominated component of the financing for Solera, which Vista Equity said it would acquire last September. The remainder of the bond financing for the deal, $1.73bn, was funded in the US market with a coupon of 10.5pc.

Investors had shied away from Solera because of its high debt and the size of the deal, said David Newman of Rogge Global Partners.

“In a very hot market it might give them the benefit of the doubt,” he said. “But when the market has seen such a big repricing, people are going to dot the i’s and cross the t’s.”

Such deals show that credit investors are increasingly demanding borrowers pare back the highly leveraged and covenant-lite structures that have been seen in recent years.

The leveraged buyout market has struggled since Carlyle, a private equity group, delayed its debt offering for an $8bn takeover of Veritas, a data storage business, in November amid increasing investor nervousness. The deal was repriced at the end of January to $7.4bn.

High-yield bond spreads, a measure of risk compensation against owning government bonds, reached their widest since 2011 in February, according to the Barclays average for the US market.

Spreads have since fallen and, last week the asset class recorded its largest inflow from funds seeking to buy junk bonds for 16 weeks, according to EPFR.

But others are stepping back. Managers of collateralised loan obligations are finding it hard to get sufficient returns from selling investors debt in which loans are bundled together.

The stoppage of the CLO ‘assembly line’ is also pushing buyout groups and banks to consider more private debt to get deals done.

Alternative investors such as direct lending funds have capital to extend relatively large loans and can agree terms faster than public markets. In return they usually demand higher yields, given private loans are harder to sell.

Goldman privately placed the debt used to finance the buyouts of SolarWind in the US and TeamSystem in Europe. Last week Frigoglass, a fridge and bottlemaker, was forced to cancel an agreement to sell its glass business after its acquirer, GZI Mauritius, could not raise the necessary debt.

Buyers are reluctant to invest in newly issued debt in part because prices on older loans on secondary markets, where liquidity has evaporated, are more attractive.

“There’s a number of instruments out there with no bid,” says one private debt investor. “In second-lien [subordinated debt], pricing of these loans is in freefall.”

Some buyout firms, including CVC, Europe’s largest, moved quickly last year to finance deals before the storm broke on credit markets.

CVC’s $4.6bn acquisition with a Canadian pension fund of Petco, the pet-supply company, was agreed later in the year than Vista’s deal to buy Solera, after executives worked through the Christmas holiday to knit together a group of underwriting banks.

Other firms have also turned to private debt to close deals. This year’s largest buyout so far, Apollo’s $15bn deal for home-alarm maker ADT, sold preferred stock to a subsidiary of Koch Industries, so that it would not have to fully refinance ADT’s bonds in the markets.

Published in Dawn, Business & Finance weekly, March 7th, 2016

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