Leveraged Loan Bankers Say 50% of Companies on the Edge
According to leveraged finance specialists gathered at the November 26 Debt Brief Europe conference in London (keynote theme: "Who will finance future deals?"), up to half of the companies taken private in the past three years face potentially serious problems with continuing to finance their debt.
The Wall Street Journal on December 1, reporting on the meeting, quoted the investment director at Japan's Nomura Mezzanine as describing "a black hole of economic morass." The WSJ described the situation in more prosaic terms, merely predicting "substantial casualties".
More concretely, Standard & Poors reports a 100% increase in the year to October 30 in companies breaching their bank loan covenants, requesting waivers from creditors "or related restructurings among speculative-grade industrial companies [i.e. LBOs]." Moody's Investors Services, according to the same WSJ article, "expects the five-year global high-yield default rate to more than triple to 35.1% from the current 10.2% by 2013.
In addition to the growing number of covenant breaches and outright defaults, the ticking time-bomb of so-called PIK (payment in kind) notes weighs over the LBO debt market. Covenant-lite loans (i.e. loans with few restrictions) were granted in abundance at the height of the LBO boom, allowing companies to skip interest payments by exercising an option to issue more bonds (the PIK notes), funding debt through more debt. According to Standard & Poors, the total volume of outstanding PIK bonds now stands at over USD 33 billion, most of it attached to leveraged buyout deals. At least 18 companies taken private have issued PIKs (including Harrah's Entertainment, US hospital chain HCA and Texas energy provider TXU, 3 of the biggest LBOs) - and not all companies have exercised their PIK options. PIK notes allow the portfolio companies to (temporarily) conserve cash but can hasten bankruptcy by adding to the accumulated debt burden while flooding collapsing debt markets with still more dubious paper.
HCA, for example, taken private for USD 33 billion in 2006 by KKR, Bain Capital and Merrill Lynch, carries USD 26 billion in debt on its books. With net income down dramatically compared with what it was in the year of the buyout, the company skipped a recent cash interest payment on a part of the senior loan, hoping to save an estimated USD 145 million each year by issuing PIK notes at over 10%. But the loans will add more debt each year than was saved by skipping the interest payment!
Unions representing workers in all these heavily indebted companies should be bracing for tough negotiations. Behind the traditional bargaining representative on the other side of the table now stands an intricate leveraged financial construction, requiring an expanded union bargaining agenda.