Wednesday, August 5, 2009

Coming Wall of PEU Refinancings

Private equity underwriters borrowed heavily during the go-go buyout years. They put down as little as 15% in a cheap credit environment. Times changed, but the deal clock still ticks. At the 2009 Wharton Private Equity & Venture Capital Conference, a panel spoke of major refinancings in 20012-2013. Consider the words of one private equity underwriter (PEU):

Peter J. Clare, managing director at the Carlyle Group, predicted that credit markets would remain expensive for close to two years, suggesting it would take at least that long for the banking system to get its bad assets off the books and recapitalize.
It turns out the banks aren't the only ones with a problem. Carlyle's HCR ManorCare has billions in securitized debt going for a discount.

The health care properties REIT HCP has acquired a $720-million stake in first mortgage debt of HCR ManorCare at a discount for approximately $590 million. The $720 million participation represents 45% of the $1.6 billion most senior tranche of mortgage debt owed by Toledo, OH-based HCR ManorCare, which operates skilled nursing and rehabilitation centers.

Their highest quality mortgage debt sold at a $130 million discount, an 18% haircut. HCR ManorCare's $3 billion in mortgage debt comes due in 2012. Who will step up and refinance?

What do good financial vultures do during difficult times? They look for new ways to find carrion.

Regarding the risk-return ratio, Clare added, the debt market represents one of the best investment options. He suggested thinking about this market as two buckets. One is the debt of healthy companies returning 15% to 25%. The other is the debt of distressed companies that could be purchased to gain control of the business or drive it into a restructuring. Such an approach will become increasingly popular, he said, though it is still early in the process. A lack of covenants and other mechanisms that would trigger default sooner are delaying inevitable restructurings. "Given the maturities, this is going to continue for four or five years at a minimum. We're in the top of the first inning in terms of restructuring and distressed-debt opportunities."

Forced divestitures will also provide opportunity, he said. Major companies under pressure, such as AIG and Citigroup, will need to unload desirable businesses. "It will take a while for buyer and seller expectations to line up." However, "the companies that become available to us will be at valuations that are more attractive."

Carlyle will buy debt and take over companies via the back door. Peter should know as it happened to Carlyle with SemGroup, an energy pipeline company. Senior lenders stand ready to take over Carlyle's IMO Carwash. Thus, Carlyle wants friendly firms holding their affiliates' debt. HCP must be the good guys.

They'll also buy distressed assets from companies under the financial gun. Carlyle's good deal on AIG and CitiGroup businesses likely mean less in taxpayer pay backs.

But there's more. Cash strapped municipalities and states will sell off prime public infrastructure on the cheap to the PEU boys.