A GBP4.3bn wall of private equity UK acquisition finance is due for renewal this year, which could lead to punishing borrowing conditions for private equity backed companies from banks
A GBP4.3bn wall of private equity UK acquisition finance is due for renewal this year, which could lead to punishing borrowing conditions for private equity backed companies from banks looking to shore up their cash positions, according to City law firm Trowers & Hamlins.
The calculation is based on UK management buyout activity figures reported by Nottingham University Business School’s Centre for Management Buy-Out Research with a deduction for intervening exits, based on a sample portfolio of large buy-outs from the BVCA Report on the Performance of Portfolio Companies 2008.
Trowers & Hamlins say that the estimated GBP4.3bn wall of private equity UK acquisition financing will need renegotiating just as liquidity is in short supply. The firm warns that banks are often extending loans only with onerous lending conditions attached by demanding tough covenant agreements before providing new facilities.
Says corporate partner Andrew Watkins (pictured): ‘We are anticipating a GBP4.3bn wall of private equity buy-out loans coming up for renewal this year as leveraged deals made during the boom years fall to be refinanced. This value only represents buy-out activity in the UK and not UK private equity invested in foreign companies, which would increase the pot substantially.
‘The private equity buy-out market grew rapidly in the years following the dotcom bust and lots of big, highly leveraged deals were made. That debt is now coming up for renewal and any private equity deals that haven’t been exited will need refinancing in a transformed economic landscape.’
Trowers & Hamlins warns that with liquidity levels low and with a large amount of debt falling to be renegotiated within a small time frame, private equity backed companies could find themselves borrowing on much worse terms than before.
Watkins says: ‘Until recently refinancing the debt on a private equity buy-out was straightforward and if the original lender didn’t want to play ball the borrower could always turn to another player. Now the rules of the game have changed. We’ve even seen banks demand repayment of the principal sum from household name companies with sound fundamentals rather than extend them new facilities.
‘Private equity backed companies coming to the banks expecting to extend their loans are finding that even when the bank will provide the facilities, it will only do so with tough new covenant conditions. These covenants might mean a company has to completely rework its business plans, for instance when a new loan-to-value ratio is set on a company hoping to win market share during the downturn by expanding aggressively.’
Trowers & Hamlins says that some companies looking to refinance their buy-out debt might already be breaching or be about to breach the covenant conditions set out in the original loan agreement. Such companies can approach the bank for a covenant waiver, which is a period of grace to rectify their failure to adhere to the terms of the loan.
Watkins says: ‘Private equity backed companies that are in breach of, or look like they might breach, their existing covenant conditions are in an even tougher position. Banks are demanding more money and attaching stringent conditions before granting a waiver. Any company that fails to approach its lender for a covenant waiver from a position of strength may find itself leaving with a bloody nose as the banks tighten up on lending conditions.
‘Banks are charging a large fee to grant a waiver, which effectively acts as an insurance premium on the risk they’re taking on the debt. But in some cases they’re also using the waiver to beef up their protection by re-setting the covenant agreements, for example by making the loan-to-value ratio more stringent. Taken together these are powerful weapons at the banks’ disposal and, with liquidity in short supply, they are not afraid to use them.’
Trowers & Hamlins says that if a company is in breach of its covenants the bank can often demand payment of the outstanding loan. If the private equity buy-out was highly leveraged the investors in the original deal may be left with nothing after the bank has taken back its money.