INSIGHT-Private equity feels squeeze from junk loan crackdown

Fri Feb 13, 2015 12:20pm EST
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By Greg Roumeliotis and Olivia Oran

NEW YORK Feb 13 (Reuters) - Big private equity deals have fallen through or had to be reworked in recent weeks because many banks, under U.S. regulatory pressure to reduce their risk-taking, are no longer willing to provide as much debt as their clients want.

This could lead to lower returns for private equity investors, because they are being asked to put more of their own money into deals, potentially reducing their return on equity. Reuters interviews with several private equity executives and investment bankers, who asked not to be identified disclosing confidential information, show that buyout firms now regularly project annualized returns of about 15 percent when they agree to deals, even as they promise 20 percent-plus returns to investors.

Last month, a potential $7 billion acquisition of Canadian satellite company Telesat Holdings Inc by Ontario Teachers' Pension Plan and Public Sector Pension Investment Board was scuppered by financing issues, according to people familiar with the matter.

A consortium of banks, led by JPMorgan Chase & Co, had offered to finance the deal for Telesat's parent, New York-based Loral Space & Communications Inc, offering much more debt than regulators are comfortable with, the sources said.

After discussions with regulators, however, JPMorgan revised its debt financing offer down, offering to lend an amount equal to closer to six times a measure of Telesat's cash flow known as earnings before interest, tax, depreciation, and amortization (EBITDA). A JPMorgan spokeswoman declined to comment. In 2013, the Federal Reserve and other U.S. regulators set six times EBITDA as a guideline for the maximum debt they see as reasonable in most deals.

For two years, banks tested that guideline, and although they were reprimanded in letters for exceeding it, they were willing to accept a slap on the wrist. Now, most regulated banks are no longer willing to go much above the guideline, industry sources said.

Data is beginning to bear this out-average levels of debt relative to EBITDA, or leverage, have dropped to 6.3 times so far in 2015, versus a 6.6 percent average in 2014, according to Thomson Reuters Loan Pricing Corp. Industry sources expect it to drop further.

"We are at a point that (the guidance) is actually having an impact," Joshua Lutzker, a managing director at buyout firm Berkshire Partners LLC, told the Harvard Business School Venture Capital and Private Equity Conference earlier this month. "There are a number of deals that did not get done or that have restructured."   Continued...