There is light at the end of the tunnel, yes. But it's the headlight of an oncoming train. From the start of the credit boom (back in those heady days when covenants were lite, bankers were throwing money at private equity, and the financial engineers were scheming to buy the Good Lord out of Paradise at a debt-to-Ebitda ratio of 9.5 times), there were warnings of impending doom.
And they are still coming, loud and clear. A new report by London law firm Freshfields Bruckhaus Deringer LLP entitled "The New Normal" says the global private equity industry will have to refinance more than $814 billion of leveraged buyout debt over the next six years, with more than $80 billion due for refinancing in 2011 alone. A peak of almost $200 billion is expected in 2014; and while U.S. and Canadian companies will need to refinance slightly more leveraged buyout debt than their European counterparts this year ($39.2 billion in North America, compared with $36.6 billion in Europe), the positions will be reversed thereafter.
Over the whole period, European private equity portfolio companies account for more than half -- 52%, or $424 billion -- of the debt maturing by 2016, ahead of North America, at 43%, or $352 billion, and relatively small amounts for Asia and the rest of the world. And of the European total, the U.K. accounts for by far the largest portion, and needs to refinance $120 billion by 2016 and $14 billion in 2011.
"LBO refinancings are ramping up, with $80 billion due for refinancing this year alone and $92 billion next year, followed by a whopping $174 billion in 2013 and $196 billion in 2014," says David Trott, head of U.K. banking at Freshfields and one of six partners who worked on the report. "Only by the middle of the decade will pressure start to ease."
Are debt-laden companies and their sponsors about to be crushed by maturing debt? Or are there refuges in the tunnel wall, where they can stand in safety while the train rushes past?
Trott is relatively sanguine.
"I'm not predicting a crash," he says, arguing that many companies will be in a position to reduce debt and put their finances on a sounder footing and that few banks will want to push companies into bankruptcy. "There are techniques out there to deal with this."
Trott talks of "an armory of solutions likely to be deployed," including full-balance-sheet restructurings, capital injections in exchange for deleveraging, and covenant resets "with an equity injection and maybe a maturity extension being factored in," as well as debt-for-equity swaps, where the sponsors simply walk away. He foresees only rare insolvencies.
A further positive trend is the growing European use of bonds in place of traditional bank loans, particularly at a time when bank lending is under pressure from the regulatory capital demands of Basel III. "A lot of the slack will be taken up by the high-yield bond market and the debt capital market," Trott adds. "There are even some signs of a revival in [collateralized debt obligations]."
However, Jonathan Guise, of debt advisory boutique Marlborough Partners Ltd., is less certain. He agrees there has been a lot of work amending and extending existing debt arrangements among bigger companies, helping to spread the debt maturity over a longer period. And he points out that the high-yield market, which is seen as an increasingly viable alternative to bank lending in Europe, remained open even during the recent sovereign debt and geopolitical crises.
"This time round, there is a feeling that high yield is here to stay," he says.
But he worries midmarket companies will find it harder to persuade banks to "amend and extend," stretching the maturity of their debt for a year or two in exchange for a relatively affordable increase in interest payments. Much will depend on the makeup of the lending syndicate. Are the original banks still in the leveraged loan business? Will other creditors accept a deal, or insist on being bought out at par?
Unless such companies -- or their private equity sponsors -- approach their banks well in advance, they may be forced to go for a full, and much more expensive, refinancing. And even those that do allow themselves time to negotiate may find their lenders unforgiving or unable to extend, whatever price they are prepared to pay for their debt.
For some such companies, which are too small to go for a high-yield bond, a train crash may be very hard to avoid.