The junk rally and buyout bailouts, updated | FT Alphaville

The junk rally and buyout bailouts, updated

Bloomberg Businessweek has an update on the latest refinancing efforts of Energy Future, previously called TXU and once known as The Biggest Leveraged Buyout of All Time.

Bought for $43bn by private equity groups KKR and TPG in 2007, the company’s revenues nosedived along with the price of natural gas and it is now trying to extend the maturity of its loans coming due this year — and will pay a hefty price for the privilege:

Lenders holding $15.37 billion of term loans agreed to push their due date to 2017, according to an Apr. 13 news release. They also agreed to extend revolving line of credit and letter of credit loan maturities. In return, the company offered to pay its lenders a 3.5 percent fee and an extra 1 percentage point a year in interest for the extended term and letter of credit loans. That would be $574 million upfront and $164 million in annual interest for as long as six years. On Apr. 7 lenders approved changes to Energy Future’s loan agreements to allow the company to address a claim by Aurelius Capital Management, a hedge fund that said it had violated the agreements. Lenders that agreed to the change were paid a fee of half a percentage point of the loan amount, according to a regulatory filing.

The occurrence of such refinancings, of course, has been among the well-chronicled consequences of loose monetary policy, even if most of them aren’t on such a large scale as this one. Other refinancings of LBO debt this year have included those of First Data, Clear Channel, and Univision.

Driven by a seemingly insatiable demand from investors for junk debt, the immediately beneficial impact has been to keep default rates at historical lows during a time when the economy didn’t need any added stresses.

Of course, there’s a dark side. Back to Bloomberg:

Refinancing the debt may only postpone the threat of default. The price of credit insurance on Energy Future, which had long-term debt of $34.2 billion as of Dec. 31, indicates that investors believe it has a 74 percent chance of failing to pay off its loans. “I don’t know that this is enough to save them,” says Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, N.M. The fees and extra interest are “a lot of dough.”

When we spoke to fixed income investors at the end of last year, we were skeptical that the extraordinary 2010 junk rally could last much longer — the asset class no longer seemed cheap. But asset managers insisted there remained room for further spread tightening.

And they’ve turned out to be right, even if they’re now (finally) getting a bit nervous:

And so the question has been whether lax monetary policy has bought companies time to fix their balance sheets (and themselves) in a more benign economic environment, or whether the inevitable has merely been postponed — as per the analyst quoted by Bloomberg

Moody’s, for instance, has cautioned that many low-rated companies that are now refinancing will hit a looming maturity wall in just a couple of years.

The optimistic retort is that the wall will look completely different by the time these companies hit it, and everything depends on what happens between now and then. If so, a restructuring of Energy Future’s debt in a few years would be an exception (though a rather large one) and not the rule.

It all remains unclear, but a recent report from Moody’s Analytics adds one more twist, arguing that the forecast end of QE2 in June will further accelerate the pace of both refinancings and IPOs in the months until it’s over:

Private equity owners of existing leveraged companies have been negotiating better debt structures with lenders through refinancing. Importantly, much of the restructuring has benefited banks and secured lenders, likely reducing concentration risk for some and freeing up balance sheet for others. Refinancing has now given way to recapitalizations, where private equity firms pay dividends through debt financing and/or issuing equity through IPOs. We think the return to the equity markets through public equity offerings may signal a turning point in the LBO cycle — reinvigorating a return to new leveraged financing deals.

The report, which we’ve posted in the usual place, finds that the market’s implied rating for the debt of the largest 25 buyouts is higher than their Moody’s ratings, and that the prices of leveraged loans have continued to climb — and implying that, among other things, the ability of these companies to refinance has made the markets more comfortable with their existing debt.

As the FT pointed out last week, the return of dividend recaps mentioned by Moody’s Analytics has this year been joined by looser covenants and Pik toggles. Assuming it happens, then presumably we can expect the same characteristics for the debt extended to the new round of leveraged buyouts that Moody’s Analytics is anticipating.

We’re not thrilled about that. Moody’s Analytics refers to these refinancings as “credit positive in the near term.” Of course, the thing about the near term is that eventually it ends.

Related links:
Shiny junk resists a funk – FT Alphaville
High yield – up against the wall, eventually – FT Alphaville