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Leveraged buyout boom set to burst?


Have the LBOs of the mid-2000s primed a financial time bomb?

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If you have a leveraged buyout (LBO) loan that is set to mature between now and 2016, form an orderly queue. According to business research company Dealogic, some $2 trillion of loans need to be rolled over globally, including $550 billion in Europe.

These astonishing numbers are the legacy of the LBO boom in the run-up to the 2008 financial crisis, when private equity firms bought companies by using the assets of the acquired company as collateral for borrowing. Some of the best known examples include the £11.1 billion purchase of FTSE 100 health and beauty group Alliance Boots by KKR, and Terra Firma’s ultimately doomed £4.2 billion acquisition of music company EMI, both in 2007.

LBO loans were typically on seven- to 10-year terms with the expectation that on maturity they would either be paid off because the buyout had been so successful, or easily refinanced by willing banks.

But, of course, no one had factored in the financial crisis, the meltdown of the banking sector and the subsequent pressure on banks to shore up their balance sheets. So it is remarkable given the tumultuous events of the past four years how small an obstacle the so-called ‘refinancing wall’ has proved so far.

“Everybody was expecting it to be a bigger problem than it has been,” says Graeme Smith, a partner at corporate finance firm Zolfo Cooper. He gives two main reasons for this: firstly, we are in a low-interest rate environment and secondly, certain companies have been able to refinance using the buoyant high-yield bond markets.

Graham Olive, head of acquisition and strategic finance for northern Europe at French bank Natixis, says that companies with “a good story to tell” have made solid progress in refinancing their facilities.

“A good story,” he explains, “is a good trading record through the crisis and a demonstrable track record of deleveraging. We want to know how the company can repay the debt in three to four years’ time.” Other indicators of “a good story” are the company having potential opportunities in emerging markets and taking a proactive approach to technological threats.

A begging bowl

The news for companies which have struggled in the downturn is less bright. The Basel III regulation requires banks to hold more capital on their balance sheets and a number of major European banks are trying to build up this capital by shrinking their loan books and selling them off.

Meanwhile, the return criteria that banks are looking for (generally a return on capital of 8 percent upwards) and the strength of the client relationship with the borrower are much more stringent than they were five years ago. “It’s easier for a bank to refinance an existing loan where it’s known the company for a number of years than to finance a new transaction,” Olive explains.

In addition, banks want to reduce their exposure to ‘weak’ sectors such as retail, real estate, automotive and non-digital media.

To complicate matters further, companies may have leveraged loans with a syndicate of up to 30 banks. “If you have a £500 million facility divided across 12 banks, you need to get all of them to roll across the amount for the refinance,” says Philip Butler, head of leveraged finance at law firm DLA Piper.

So what are the options for companies who have fallen out of favour with their banks and are not large enough to use the bond market? “Specialist lenders are looking to fill the gap that banks have left,” says Olive. “Specialist institutions, pension funds and fund managers. The US private placement market has also been used recently.”

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