LBOs under the microscope

Here is a seemingly sobering fact: six of the 10 largest leveraged loans at risk of default are held by private equity-backed companies, dubbed “primary loans of concern” by Fitch Ratings.

With private equity firms’ reliance on debt to finance transactions, that might not be a surprise, but the good news is sponsor-backed leveraged loans don’t hold outsized weight when compared with their portion of the total leveraged loan market.

“I think going back pre-crisis the equity cheques were smaller, like 20 percent or 30 percent,” he explains. “What you’re seeing post-crisis is the equity cheques have gotten larger, which has helped improve recovery structure.” – Mike Paladino, head of Fitch US leveraged finance group

“Why you’re seeing so many [private equity-backed leveraged loans] is a function of how the LBO market works,” says John Kempf, a senior director in the rating agency’s US leveraged finance group. “Most of the other names [on the list], you’re moving away from a lot of the other PE-backed companies.”

Some 62 percent of the $1.1 trillion leveraged loan market consists of sponsor-backed loans, according to the ratings agency. Of that total, 86 percent consist of broadly syndicated loans.

The list is based on three parameters, says Eric Rosenthal, who holds the same title as Kempf. Those are the borrower’s credit ratings, debt pricing in the secondary market and other market events or pertinent information, such as the hiring of restructuring attorneys.

In addition, Fitch also has criteria for what constitutes a default: Chapter 11 bankruptcy filings, the most common type; distressed debt exchanges; and missed interest payments.

iHeartCommunications takes the top spot on the loan watchlist with $6.3 billion. That is just part of the company’s $20 billion in debt, the product of a $17.9 billion leveraged buyout by Bain Capital and Thomas H. Lee Partners of the media company, then named Clear Channel Communications.

“iHeart is reflective of the pre-[global financial] crisis” mentality, Mike Paladino, head of Fitch’s US leveraged finance group, says of the deal, which was announced in November 2006 and closed in July 2008.

“I think going back pre-crisis the equity cheques were smaller, like 20 percent or 30 percent,” he explains. “What you’re seeing post-crisis is the equity cheques have gotten larger, which has helped improve recovery structure.”

Market data doesn’t disagree either. In 2007, the average equity contribution to a broadly syndicated LBO was under 30 percent, according to Thomson Reuters leveraged loan data. Over the first three quarters of this year that figure stands at a much more robust 40 percent.

That doesn’t mean post-GFC deals are immune from financial difficulties though. Two such deals, involving Riverstone Holdings portfolio company Fieldwood Energy and The Carlyle Group-backed Getty Images, hold the second and third spots. Fieldwood lists $3.29 billion of outstanding leveraged loan debt, while the figure for Getty is $1.9 billion.

Both Fieldwood, an oil and gas exploration company, and Getty, an image-archiving company, operate within sectors that have been facing difficulties and secular upheaval.

While the larger LBOs are well accounted for on the list, lower mid-market buyouts are largely excluded because of the opaque nature of that market, Paladino says. The watchlist tracks everything with $100 million of debt and above, meaning that if a $20 million-EBITDA business is levered five times, it could potentially make the list.

Those in the lower mid-market have no readily available liquid market in which to dump troubled credits, Kempf explains. Those firms have extra incentive to work through any financial woes portfolio companies may encounter since the credits will likely be in the lender’s book for a while.

Where this list goes will be interesting to follow since so many broadly syndicated LBOs now use covenant-lite loans, yielding looser terms and less negotiating power for the lender. It’s not an unimaginable situation that real value in the company slips away before the lenders can get involved. By that time it may be too late.

HEART BREAKING

In its most recent financial statements filed with the US Securities and Exchange Commission, iHeartCommunications said management, while preparing its quarterly financials, “considered the conditions and events that could raise substantial doubt” about its ability to remain a going concern.

The company faces a wave of debt maturities, which includes $366.9 million due before the end of the year, $308.5 million next year and $8.37 billion in 2019.

In addition, the firm attributed its net losses and negative cash flows from operations for calendar years 2015 and 2016 to “significant cash interest payments arising from our substantial debt balance”. The firm faces interest obligations of $344.6 million in the fourth quarter alone.