Why repay your debt when you can buy it back at a fraction of the price?
A fairly straightforward question, from S&P LCD. Debt buybacks look like the money spinning scheme du jour goes on the email.
The gig is simple: 12 months ago, you took over an attractive but flagging company and leveraged it to the hilt to fund the acquisition. Now the banks who lent you the cash are desperate for respite, and just as they uncomfortably found themselves lending at low rates to you last summer, now they find themselves uncomfortably trying to offload the debt back to you this year, via some kind of shell company.
Witness the big deals to date: £2.5bn of Alliance Boots debt in May, sold to Apollo, Blackstone, TDR and TPG for around 91 cents on the dollar, for example.
The stupid clever thing, of course, is that you can make even more money if you lever up your stake in buying that debt. The straightforward method might be to set up a shell company, in which the buyout firm takes an equity stake. But why bother doing that, when you can also lever synthetically? Duh. Just use a total return swap.
S&P LCD reports this has been done on a number of deals to date:
Citigroup moved to sell $12 billion worth of leveraged debt to Apollo, Blackstone and TPG in April, at about 85% of par. The deal is also thought to have been done via a TRS, with Citigroup providing finance to the sponsors at up to 4x leverage, sources say. Meanwhile, the same month, Deutsche moved to offload a $5 billion block of debt at 85-90% of par to Apollo and Blackstone, with some suggestions of a further €5-6 billion sale of European leveraged debt planned.
A total return swap is a derivative contract. The contract’s notional will be equivalent to the amount of debt to be “bought”. All a buyout firm need stump up is the haircut on the contract. The rest thus makes up the “leverage”. Then the buyout firm bears the brunt of further mark to market hits, in exchange for skimming a fat return. In net terms, the bank wipes the actual buyout debt from its balance sheet.
What about though, conflicts of interest? As S&P LCD writes:
The thought of a GP having a major seat at the restructuring table, with all the conflicts that could involve, is enough to make even some of the most sanguine bankers break into a sweat. Not only could the sponsor have very different motivations in any default situation, but it could potentially block votes on more mundane negotiations, such as security and pricing.
For this reason alone, the recent instances of sponsors’ buying up debt in individual portfolio companies (even though none of these purchases amounted to anything approaching blocking stakes) generated consternation among certain bankers.
And the end of the day, though, the banks just have to lump it.
Related links
Boots made for walking… in circles – FT Alphaville