Capital Markets

For PE, Fewer Deals but More Junk-buying

S&P report shows 13 private equity firms buying $25b to $30b of leveraged loans and high-yield debt in the first half.
Stephen TaubAugust 18, 2008

It’s no secret that private equity firms have scaled back their dealmaking amid the turmoil of the global markets and economies. But PE has been fast-emerging as a major buyer of leveraged loans and high yield debt from struggling financial institutions desperately seeking to raise capital, according to a recent Standard & Poor’s study.

Indeed, while LBO transaction volume was down 63 percent in year-over-year terms during January-to-June, for example, S&P estimates show that private equity firms including Apollo, GSO Capital/Blackstone, KKR, and TPG, bought $25 billion to $30 billion of leveraged loans held on bank books.

Altogether, Standard & Poor’s counts 13 private equity firms that were active in loan management during the first half of 2008, up from 11 in 2007 and nine in 2006. If sales volume in primary institutional markets and secondary sales are combined, private equity’s share rises to 32 percent.

“These deals can be viewed as opportunistic attempts by larger, deep-pocketed private equity sponsors to maximize risk-adjusted returns in an environment where there are few outlets for traditional strategies, such as buyouts,” points out S&P in its Global Fixed Income Research report.

Altogether, the dollar volume of leveraged loans held on bank books had dropped to $45 billion in July 2008, compared with $237 billion 12 months earlier, according to the report.

Meanwhile, other asset classes that are suffering from relative illiquidity, such as securitized debt, also stand to benefit from the increased presence of private equity, S&P points out. “Allocations to private equity could increase in the near term, as other investors underexposed to the asset class increasingly view sponsors as an appropriate vehicle for extracting superior risk-adjusted returns in leveraged finance,” it adds.

PE’s increased involvement in the leveraged finance business is a little surprising, given that the ranks of traditional asset managers and hedge funds have dwindled, either because of a lack of funds required to pull off these deals, unwillingness to add exposure to an asset class to which they already have sizable allocation, perceived superior knowledge of credits because of prior involvement in the LBO, or a relative disadvantage in terms of securing funding from bank credit departments, according to the S&P report.

“Their purchase of leveraged loans constitutes a new frontier in their investment strategy and is motivated by their search to put ample funds to work and maximize returns in an environment where opportunities for more conventional buyout activity are highly limited,” S&P notes.

Whatever the reasons for the increased PE involvement in the leveraged loan market, the private equity players are filling an important role in shoring up the balance sheets of banks. And as prices drop in other asset classes, private equity sponsors could wade into less-senior parts of the capital structure