Debt crisis turns back the clock to June 2006

Market practitioners are beginning to feel the heat as the changing debt markets have caused lenders to flex their muscles. A senior leveraged buyout banker at a large American bank has predicted the correction could lead to an end of cov-lite deals and an increased yield demanded from loans, as debt investors flex their muscles.

He said: “Incurrence-only senior loans or cov-lite deals will become extinct, while margins are going to be up 50 basis points across the board. Kohlberg Kravis Roberts’ Maxeda cov-lite plans were pulled, and the Chrysler and ServiceMaster loan packages haven’t failed yet, but watch this space.”

Cerberus agreed the Chrysler deal with DaimlerChrysler in May, putting together a substantial covenant-lite loan package to acquire the $7.4 billion (€5.4 billion) automobile company with health liabilities of over $10 billion.

According to the banker, investors are not accepting the cov-lite loan at the moment on its present terms. He said the same was true of Clayton Dubilier & Rice’s agreed $5.5 billion public to private acquisition of commercial services business ServiceMaster using a cov-lite package in March. KKR offered to add covenants to the cov-lite loans supporting its €1.1 billion ($1.5 billion) refinancing of Dutch DIY company Maxeda.

A partner at a mid-market buyout firm, said: “The Kohlberg Kravis Roberts debt fundraising for the Alliance Boots deal has come at the worst possible time for the rest of the industry.  With nearly everybody in town needed on the deal to provide the financing and with problems in the debt markets generally, deals are falling through at smaller buyout firms.”

But the banker said Alliance Boots is a drop in the ocean, with a European pipeline of about €60 billion dwarfed by the US pipeline of approximately $200 billion. “No one really knows what the price of debt is any more. Deals in the market underwritten at the height of the boom in March and April are going to have to be reworked and the cost of debt will go up.”

The partner agreed the era of cheap debt is coming to an end.  “Where in the past we could push through deals, investors have turned around and said they want to up their yield for their risk and are starting to wear the trousers in negotiations. We’ve had deals fall through and others are getting really hairy.”  Creditors are also adding in more covenants, he said. 

Yet the banker said: “This is a rational pricing correction. Debt was becoming so cheap that the CDO model didn’t work and creditors couldn’t make any equity returns. The banks carried on providing debt as they could sell it because the entire market was pricing at that level, yet this couldn’t last. We’re simply setting the clock back to June 2006.”