Among other things, some borrowers demanded and got rights to:
- Increase debt-to-EBITDA (Earnings Before Interest, Tax, Depreciation, and
Amortization) levels to 10:1.
- Freely substitute collateral.
- Have collateral “released” outright.
- Issue unsecured debt equal to the total amount of existing debt (if they
hedged or effected swaps.
- Employ PIK (payment-in-kind) options, where instead of paying interest in
cash they could substitute more debt.
- Employ PIK toggles, sometimes called “extendibles.”
PIK toggles (think of a toggle switch which is used to turn something on or
off) let the borrower can roll interest payments into principal and extend the
maturity, instead of making twice yearly cash payments. If that sounds like an
option ARM mortgage, where borrowers can choose whether to pay the interest due,
some part of it, or none of it, and roll unpaid interest into principal, it’s
because it is the exact same borrower covenant.
It’s like déjà vu all over again.
Act II: With No Leverage Private Equity Deals Fall Apart
Junk, junk and more junk. When the music stopped and the credit crisis began
last August, money and credit evaporated. Only then did it bother leveraged loan
investors that the private equity guys were leveraging their private companies
to pay themselves huge dividends – enough in many cases to repay the entire
initial cash equity investment used to underpin the leveraged buyout of their
targets. And only then did they realize that all the debt heaped onto these
companies was going to drag many of them into bankruptcy.
At that point, investors simply stopped buying leveraged loans. And the net
result is that banks may be sitting on over $150 billion of junk leveraged loans
that they can’t place. They are taking hits to their balance sheets as they have
to mark down these loans which were securitized and subject to mark-to-market
accounting. And they are terrified that the recession will drive more of these
leveraged companies into bankruptcy.
Thomson Reuters recently reported that 40 private equity companies have
sought bankruptcy this year. According to Standard & Poor’s, of 86 S&P
rated companies that defaulted this year, 53 of them were private equity related
transactions. Linens ‘n Things which was taken private by Apollo Group Inc.
went bankrupt. Sharper Image, Wickes Furniture and catalogue company Lillian
Vernon, were all taken private by Sun Capital Partners
Inc., all of them are bankrupt. Mervyn’s which was taken private by Sun
Capital and Cerberus
Capital Management LP. is bankrupt.
Also in the clutches of the three-headed-dog from Hades, Cerberus, is Chrysler LLC;
Chrysler Financial, GMAC LLC (General Motors Acceptance Corporation) (GMA) –
51% owned by Cerberus – and Residential Capital LLC,
a GMAC company. By most accounting standards, all of these companies are, if not
already, close to insolvent.
GateHouse Media Inc. (OTC: GHS), 40%
owned by Fortress Investment Group LLC (FIG), is at risk of
debt default and may likely be headed for bankruptcy. Former Lazard Ltd. (LAZ)
deputy chairman and media honcho Steve Rattner’s Quadrangle Capital Partners
may lose control of American Media Inc.,
publisher of The National Enquirer and
Star magazine, as he battles
with bondholders and may also lose portfolio company Alpha Media Group Inc.,
publisher of Maxim magazine. These few examples of
failures are just the tip of the iceberg.
Then, of course, there’s the pure genius of PE firms coming to the rescue of
troubled banks. But, TPG Capital (formerly
Texas Pacific Group) doesn’t look so genius with its $7 billion investment in
Washington Mutual Inc. (OTC: WAMUQ) which was
wiped out in a matter of five months.
It’s understandable that bankrupt target companies are suing. Mervyn’s, for
example, filed a 57 page suit against its lead dog master Cerberus, alleging
fraud among other charges. But what is not as easily understandable is that some
other lawsuits have the potential to turn the game viciously against the private
equity firms and all the major bank lenders.
