Depressed lending markets present opportunities for private equity

$1tr in leveraged loans has been affected by the collapse in investment banking, which has left the sector with far fewer sources of lending than before.

Leverage levels have crumbled in the market crisis and the demise of the investment banking industry, but the current turmoil presents opportunities for private equity firms flush with cash to buy strong companies at low prices.

“[Reduced leverage] puts downward pressure on the market value, and the low public market values mean the private equity firms can buy them very cheap,” Dennis Chookaszian, chairman of the Financial Accounting Standards Advisory Council told PEO. “We should see an increase in the private equity firms buying public companies at the current relatively low public market prices and taking the firms private.”

Of the $1.5 trillion in leveraged loans issued by the leading 15 banks in 2006 and 2007, $1 trillion are affected by the dislocation in the banking market, according to commentary from private equity fund of funds manager Capital Dynamics.

With Bear Stearns acquired by JPMorgan, Merrill Lynch acquired by Bank of America and Lehman bankrupt, it is unlikely that the resulting organisations will lend at the same levels as their predecessors, according to the Switzerland-based asset manager. Goldman Sachs and Morgan Stanley, which converted into commercial banks in September, will never again lend as aggressively as before, according to Capital Dynamics.

Leverage ratios have dramatically declined and may never reach the levels they were in the past few years, Capital Dynamics said. Chookaszian said if the credit markets free up, lending levels could return to three to four times EBITA.

“In the overheated market of the past three years, investment bankers were able to develop packaged deals with very aggressive leverage and you would see stapled financing deals at seven times EBITDA,” Chookaszian said. “The crisis hit and now, if you can get financing at all, you’ll see financing quotes of two to two and a half times EBITDA.” Chookaszian is the retired chairman and chief executive officer of CNA Insurance Companies.

Capital Dynamics said deals done in the next 12 to 18 months will generate high returns. Chookaszian said opportunities exist in the depressed markets, but he said private equity firms could have problems if the market crisis prevents their limited partners from participating in capital calls.

“Private equity firms have raised very large new funds and are sitting on a lot of undrawn available cash, but a question that you must ask is: given the market crisis will their LPs be able to provide the cash when they need to draw on it for acquisitions?” Chookaszian said.