One of the fairly well publicised outcomes of the credit crunch has been a dislocation in the leveraged debt markets, with banks unable to syndicate in excess of $200 billion of “hung” leveraged loans.
This disruption has produced additional investment opportunities for private equity houses, as they switch from holding purely equity to buying debt.
Most recently, Cinven has diversified into debt, taking a 50 percent stake in Indicus Advisers, while larger fund managers including The Blackstone Group, Bain Capital, Kohlberg Kravis Roberts and TPG have also been delving further into debt strategies. At least $10 billion in funds is being raised dedicated solely to buying discounted LBO debt.
Ordinarily, one might expect the banks to resist such market forces, but many banks selling “hung” loans (often at a significant discount) are also offering additional leverage to buyers, typically on a 75:25 debt to equity ratio.
If the banks do not wish to hold the debt, then there is no reason why PE houses should not purchase it at market rates since market forces will control this process.
Critics of the growing trend have pointed to the issue of private equity firms acquiring sufficient amounts of debt to give them blocking rights at creditor meetings, but the deals that have been done to date do not cause concern here. Market forces are such that any PE house will think very carefully before frustrating a bank syndicate, since the banks remain an essential part of the PE industry.
Potential conflicts of interest will, however, occur where a private equity sponsor seeks to use a separate fund to acquire a leveraged loan in a situation where it also holds an equity stake.
This is particularly so where the influence of the private equity sponsor holding debt is such that it effectively has a right of veto over decisions being made by the banking syndicate. This potential conflict was recognised by Cinven when making its investment in Indicus, since it has publicly stated that such investment has been set up in such a way to prevent Cinven from influencing Indicus’s investment decisions.
As the current disruption of the leveraged loan market continues, and such opportunities continue to attract private equity sponsors, I anticipate that the majority of banks will seek to limit or restrict the ability for borrowers to undertake and own debt buy backs, as well as for sponsors who acquire debt to exercise significant influence over the banking syndicates decision making process.
Even where private equity sponsors acquire leveraged loans which are free of such restrictions, I expect such sponsors to exercise extreme caution before exercising any veto rights – they are likely to continue to rely heavily on the availability of leverage and will not want to “cut off the hand that feeds them”.
Mark Spinner is a partner at international law firm Eversheds, where he heads its private equity practise.