Friday Letter Debt refinancing just got harder

The bloodbath occurring in stock markets worldwide this week bodes ill for more than one type of portfolio.  

“I’ve just lost a third of my net worth,” one London-based public market investor grumbled Friday morning, referring to the FTSE having had one of its worst weeks in history. Similar turmoil has gripped other exchanges around the globe as panicked investors reacted to a number of worrying issues – from fears earlier in the week the US was nearing default on some of its $14.3 trillion in debt to Europe’s continuing sovereign debt crisis.

The market meltdown – if it continues – spells trouble for the portfolios of many private equity funds and investors, too. There is the obvious impact to valuations, for if public market comparables collapse, buyout houses will once again be forced to severely mark down their holdings. And such volatility could slow the recent stream of public market exits – it is a brave sponsor indeed that would take a company public in such uncertain conditions – as well as sales to strategic buyers that in times of strife tend to keep cash on their balance sheets.

A bigger problem for the private equity industry could be the impact on debt re-financing.

The recovery in European leveraged loan markets, for example, had been gathering momentum. The pace of high yield bond issuance and strategic sales of leveraged credits hit record levels and reinvigorated institutional loan markets in the first half of the year, according to a report released this week by Fitch Ratings.

But the ratings agency warned an extended period of volatility in the second half of the year could affect private equity firms’ ability to refinance the circa €200 billion of portfolio company debt due to reach maturity between 2013 and 2016.

In light of this week’s market turmoil, warnings from the report’s authors seem even more ominous.”Leverage remains high and unless the de-leveraging progress is accompanied by renewed risk appetite and flows into bond and loan markets, the level of restructurings is likely to materially increase in the next two to three years,” said Cecile Durand-Agbo, a London-based director on Fitch's leveraged finance team. 

It’s hard to imagine that renewed appetite for risk taking hold anytime soon.

Ed Eyerman, Fitch’s head of leveraged finance, told us this morning that the refinancing window has now essentially been shut for everyone. “It closed last year with Portugal and then Ireland, but this year, the window remained open through the Arab Spring and the Japanese earthquake. But the US and Greek situations have effectively shut it again. When it reopens, it will be a very crowded space, and sponsors may not like the terms on offer.”

He expects sponsors to look at other options, including 'amend and extend' agreements, equity cures or asset sales to help deleverage their portfolios.

“This is the darkest hour,” Eyerman said.”But I don't think people will panic – they've been through this before.”

No one quite knows, however, exactly how things will pan out – and that’s especially true for the troubled Eurozone. In a report this week, ratings agency Standard & Poor’s said private sector output had stagnated and confidence throughout the European Union was decreasing markedly. Growth rates among EU member states are wildly divergent, creating a looming performance gap. And serious questions remain as to the likelihood of sovereign defaults and the viability of the euro as a currency as well as the European Union itself in its present form.

The implications for euro-denominated private equity funds, in particular, could be severe, or as some sources have pointed out, they could be beneficial for savvy managers able to capitalise on market dislocation. One thing, however, is clear: these unanswered questions coupled with this week’s public markets panic will not make life easier anytime soon for private equity professionals.

PS – Next week, PEI will bring together a panel of European private equity veterans to examine these issues and explore how their organisations are confronting them. The roundtable discussion will be published in the September issue of  Private Equity International.