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A Refi Conundrum As PE Loans Come Due
Round of refinancings in retail and other industries could be on the horizon.
November 17, 2008
As the credit crunch continues to migrate to new categories of lending, one of the stress points many expect to come to the fore soon is a round of private equity loans struck in the first half of the decade.
How to handle those loans could be one of the critical questions next year for bankers, as well as for the economy as a whole. Opinion appears divided on how that process is likely to go. The loans may not be the kind of credit bankers would extend today, but some say a round of refinancing is all but inevitable, given the alternative: a major round of commercial bankruptcies.
In a three-year span that started in 2004, when the market was flush with liquidity, private equity firms used borrowed money to invest in a range of businesses, often targeting out-of-favor ones like department stores and electronics sellers. As with many such investments, these ones were a bet that operations could be improved in relatively short order, with sales of the companies to follow, and that if more time were needed, the loans would be easy to roll over.
Now selling those businesses is hardly an option at all, especially in the hard-hit retailing sector. And refinancing options do not look much better, given the tightness in credit markets.
Edward Kelly III, Citigroup's head of alternative investments, put it simply at a conference last week in New York. Many investment vehicles are hurting, he said, but "it's tough in particular for private equity."
Some corporate finance specialists say that in many cases, banks have motivation to work with borrowers—as is happening on the mortgage side of the business—to roll over debt and avoid the ripple effect a rash of insolvent companies would have on the economy and the banks' ability to recoup the money they have lent.
"It's mutually beneficial to everybody involved, whereas bankruptcy could be mutually destructive," Eric Goodison, a partner in the corporate department of Paul, Weiss, Rifkind, Wharton & Garrison in New York, said in an interview last week.
Inevitably, borrowers will face refinancing fees and higher interest rates, but for investors whose equity holdings might be wiped out by a bankruptcy, that may be a price they have to accept. And all involved can postpone the maturity of the debt until what they collectively hope will be better financial times two or three years from now.
"To work these things out, lenders have to step in. There is no functioning credit market right now for leveraged buyers. That will probably be the last market to come back," Goodison said. "Either the bank provides the refinancing, or it runs the risk of dealing with a bankruptcy that could destroy value and impair recovery of their money."
He represents companies that face maturing debt starting next year, but observers without such connections share his views and see a need to reinvigorate investing in companies.
"If I were a lender right now, my inclination would be to roll unless the borrower is so far gone" that it would do no good, Jeff Davis, a veteran bank analyst and principal at Wolf River Capital, said in an interview last week. "If you have someone you can nurse along, you're better off not putting them in the [nonperforming] bucket yet. It also feeds into the political side, where you can say that you are doing your part to lend and giving someone the benefit of the doubt."
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