And a happy Fourth of July to you, too. Bankers and financial sponsors have suddenly met some serious resistance from both bond and loan buyers as deals pile up ahead of the US summer break. So far, only a couple of small deals have actually been postponed, but several others are undergoing surgery to make them more palatable. The sticking point seems to be the risky features, such as weak covenants and payment-in-kind notes, allowing issuers to defer cash interest payments.

Issuers had it coming to them. At some point, buyers would balk at the skimpy interest cover – it has fallen to 1.3 times on large leveraged buy-outs, according to Standard & Poor’s LCD data. Their resistance is bad news for underwriters and private equity. The former now have to worry about being stuck with bridge loans, a type of funding that is unsecured and concentrates exposure as well as tying up precious capital. Of course, they get paid for the pain, at yields probably in the 10 to 11 per cent range. But they would rather get the stuff off their books as soon as possible.

For financial sponsors, market mutiny is more ominous. In the short term, they can probably shrug off the extra expense of bridge funding. An extra 100 basis points or so of interest expense should not be enough to undermine the businesses they are acquiring, though it will, of course, pare back the high rates of return for private equity. Longer term, however, the resistance in the markets could make it harder to keep deals flowing. The flexibility afforded by the loose financing terms probably made the difference between a deal looking possible and it looking too risky. Skimpy interest cover looks a lot more scary if the payments cannot be postponed. This could be the beginning of a serious bondholder revolt. That would be a fireworks show worth watching.

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