Refinancing wall becomes refinancing hill?

The “wall of refinancing” looks less precipitous than it did a year ago. But has the private equity industry just postponed its day of reckoning? Sam Sutton reports

Mountains can only be conquered one step at a time. Though private equity has yet to reach the summit, the industry has ably managed its ascent up the veritable Everest of debt set to mature over the next four years. 

“It’s changed from a refinancing wall to a refinancing hill,” says Bill Halloran, Bain & Company’s head of North American private equity. “It’s still there, but it’s there for 2015 and 2016 … it’s smoothing it out over a few different years now.”

In 2010, Bain’s annual private equity report estimated that roughly $850 billion in maturing debt – 85 percent of which is held by private equity companies – would be maturing through 2016. More than $592 billion of that debt was set to mature in 2013 and 2014, posing a huge threat to firms holding distressed, highly-leveraged portfolio companies. 

At the time, many industry observers gravely predicted that tightening credit markets and firms’ inability to raise capital on stagnant public markets would create an environment that was ill-equipped for refinancing on this scale. Thankfully, they were wrong – at least in part.

“We’ve been seeing a huge spike in maturities in 2014 being smoothed out over the next few years,” Ropes & Gray partner Jay Kim tells Private Equity International. “The size of the pile isn’t that different …. [But] instead of a short spike, it’s over a long period of time – like a long speed bump.”

So what has smoothed the road to maturity? A combination of loan term amendments and extensions, high-yield refinancings and the paying down of debt by portfolio companies, sources say. As a result, Moody’s Investor Service reckons the amount of speculative debt maturing in 2013 and 2014 now stands at $234 billion – well below the figure it was expecting back in 2010. The impact of this has been keenly felt in the credit markets. 

“It has eased some of the concerns. That’s why you’ve seen some of the institutions [i.e. lenders and subordinated debt providers] re-entering the market over the past year,” says Richard Zytkowicz, managing director of advisory firm LM+Co. The shrinking debt obligation provides opportunities for investors and investment bankers to adjust the balance sheets of troubled companies by modifying future deal equity ratios toward more equity and less debt, he added.

However, the level of debt remains quite large because of the prolific use of amend-and-extends – a strategy perceived by some as kicking the can down the road. Speculative grade loans maturing between 2012 and 2016 total $668 billion, according to Moody’s. Furthermore, the health of the credit markets would undoubtedly be affected if Europe’s sovereign debt crisis continues to worsen.

Tackling the remaining debt load can be accomplished through a number of strategies, sources say. The use of junior capital, like mezzanine and equity, would provide stability if injected into the more levered companies. Repayment of loans with companies’ excess cash flow could also do the trick. Some finance professionals are pinning their hopes on a resurgent high-yield market (though that would only work for larger companies).

One area that would pose the greatest opportunity for private equity firms would be the return of the market for initial public offerings, an option that was sidelined during the latter half of 2011 after volatility overtook US public markets. As stock markets continue to improve, IPO offerings provide a strong opportunity for firms to pay down debt without resorting to pushing maturities beyond 2016, sources say.