The US’ worsening subprime mortgage market and investor fears over the corporate debt markets fueling private equity deals were acknowledged this week by US Federal Reserve Chairman Ben Bernanke.
“Credit spreads on lower-quality corporate debt have widened somewhat, and terms for some leveraged business loans have tightened,” Bernanke said before both the House’s Committee on Financial Services and the Senate’s Committee on Banking, Housing, and Urban Affairs. “Even after their recent rise, however, credit spreads remain near the low end of their historical ranges, and financing activity in the bond and business loan markets has remained fairly brisk.”
The changing tides of the credit market may cause the use of equity bridges and cov-lite loans to disappear from private equity deals, say some industry veterans.
Sam Schwerin, a managing partner with New York-based Millennium Technology Ventures said that until recently, lenders have been “going out to that last, last level in the amount of leverage you can put on and the terms you can accept, and the rates you can accept. So I think there’s nowhere to go but down, in terms of volume and up in terms of rates, up in terms of terms.”
Already, he said, there’ve been noticeably less deals financed with cov-lite loans, whereas “there have been an enormous amount of convenant lite deals in the past”.
The trouble lenders apparently had in syndicating $5 billion in debt they’d secured with a bridge loan for the recent $7 billion buyout of Royal Ahold’s U.S. Foodservice by Kohlberg Kravis Roberts and Clayton, Dubilier & Rice, Schwerin said, “may be a harbinger of things to come”.
Schwerin added: “That sort of thing could very, very quickly stop the aggressive set of terms on debt, which means that the value of acquisitions fall because the level of leverage and the terms that are available on debt aren’t as aggressive as they once were.”
Jamie Dimon, JPMorgan chief executive, today said equity bridges are “a terrible idea” and “bad financial policy” both for banks and private equity firms.
“It’s silly to take all that downside risk and not have any upside potential,” Dimon said.