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Risky Debt Burns Banks, Endangering Buyout Activity

The outlook for deal activity is further dimmed by the fact that investment banks are facing significant losses on leveraged buyouts they agreed to finance before markets soured.

Among the banks that could collectively lose billions of dollars on buyout loans they agreed to provide when demand for the debt was soaring are Bank of America Corp., BAC Credit Suisse Group AG CS, and Goldman Sachs GS Group Inc.

Leveraged loans are typically distributed by lenders to other banks as well as institutional investors like mutual funds and managers of CLOs. Lenders run the risk of being forced to sell paper at steep discounts if markets turn bad before they can do so.

Leveraged Commentary & Data reports that as of June 23, sellers of newly issued buyout debt were receiving an average of 94.8 cents on the dollar, down from 99.2 cents at the end of January.

That bodes ill for transactions like Citrix Systems Inc.'s takeover, CTXS, the largest private equity-backed leveraged buyout in the United States thus far this year. The agreement, which was signed in January before the stock market and bond sell-off intensified, will be financed with about $15 billion in debt, some of which is anticipated to be sold this summer.

According to those with knowledge of the situation, the banks and other lenders involved in the deal could incur losses totaling up to $1 billion if the markets do not improve by that time.

Byung Choi, a partner at Ropes & Gray LLP who assists private equity firms in arranging deal financing, stated that "lenders are finding they need to sell debt at a deeper discount than anticipated."

This is reducing banks' desire to finance new transactions. Private equity investors, who traditionally used debt as the source of the majority of the capital to fund their largest takeovers, are finding it more and more difficult to obtain leveraged loans because they are becoming more expensive.

LBO activity has decreased significantly as a result. Private equity firms have closed deals totaling $138 billion in the United States so far this year, a decrease of nearly 20% from the same period in 2021, according to data provider Dealogic.

In recent weeks, the funding situation has gotten progressively worse.

Department store chain Kohl's Corp. announced on Friday that a strategic review process had been completed without a deal, despite having entered into exclusive negotiations for a sale to retail holding company Franchise Group Inc. As a barrier to a deal, it cited "the current financing and retail environment."

Following a strategic review that failed to yield a sufficient offer, Walgreens Boots Alliance Inc. announced in late June that it had decided to keep its Boots and No7 Beauty businesses in the U.K. As a barrier to a deal, the owner of a drugstore chain mentioned "market instability severely impacting financing availability."

According to those familiar with the situation, banks involved in the syndication of the roughly $2.5 billion take-private of packaging-products maker Intertape Polymer Group Inc. by Clearlake Capital Group LP last month suffered losses totaling $30 million or more as some investors shied away from supporting an industrial company because of recessionary fears.

According to LCD, Credit Suisse CS handled the first-lien buyout loan deal, with banks like Deutsche Bank AG, Goldman, Jefferies Financial Group Inc., and BMO Capital Markets serving as joint lead arrangers.

Buyout firms are increasingly using private-credit providers instead of banks to close deals, like Blue Owl Capital Inc. and Golub Capital. These businesses can provide capital through investment vehicles created for this purpose, so they are not required to syndicate debt. Private credit typically offers more pricing stability and certainty than syndicated-leveraged loan options, despite typically being more expensive.

Private-credit providers supported the roughly $10 billion deal between Permira and Hellman & Friedman LLC to take software company Zendesk Inc. private, according to people familiar with the matter. After an initial sale process ended in failure, the deal was finally finalized in June. The company stated at the time that bidders were constrained by "adverse market conditions and financing difficulties at the end of the process."

Thoma Bravo's recent acquisition of software company Anaplan Inc. for about $10 billion was additionally supported by private credit.



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