Debt markets have been showing signs of life in recent weeks with even poorly rated companies issuing some small chunks of debt. It will have to show a lot more life soon though: about $800bn to $1,000bn of debt needs to be refinanced over the next few years for all the low rated companies that borrowed when money was easily available.
The debt was raised to pay for leveraged buy-outs in the boom years of the private equity industry.
The debt of some of the biggest buy-outs such as TXU, the Texas utility, is trading at discounted levels, partly on fears about the ability to refinance all that debt.
So the game seems to be to refinance sooner rather than later, and get a headstart on the problem.
HCA, the hospital company which three private equity firms bought in 2006, illustrates the problem. HCA raised $310m in the high yield market in February.It has also secured the right from creditors to replace some of its bank loans with bonds that have much longer maturities.
HCA has years to repay its $27bn in debt and the bulk of it does not fall due before 2013.
Nevertheless, bankers are already trying to advise clients about what they can do to handle the debt before it comes due, given how dramatically capacity in the debt market has dwindled.
John Eydenberg, head of financial sponsors for Deutsche Bank, says: “Plan A is to do what HCA is doing and take the bank debt out and replace that with bonds.
“Firms like KKR are chipping away at the debt of their portfolio companies. Everyone should be doing that.”
In addition to trying to refinance a portion of its debt, HCA could, they say, try to list itself and use the proceeds partly to pay down debt and reduce its leverage. But stock market sentiment remains fragile.
HCA could also sell assets. But in these markets, there are not many buyers.
Other private equity firms are asking (or forcing) creditors to exchange debt in a trade-off between greater security and giving up a claim on part of the debt.
The maths is so daunting that bankers refer to a “maturity cliff” that few firms will be able to surmount. “But these are just bites at a problem which could amount to $1,000bn,” says a managing director in charge of the portfolio of debt backing buy-outs for one leading bank.
In past cycles, private equity firms used the bond market, where debt can be up to 10 years in duration, to finance their buy-outs. During the recent buy-out cycle however, they took advantage of generous terms and supply in the loan market, even though loans have to be repaid sooner.
But now most buyers of these loans have gone away, as have the buyers of complicated securities known as collateralised loan obligations. Hedge funds that could once borrow a lot of money to buy the loans, now can not borrow to make such investments worthwhile.
Stephen Kaplan, a founding principal and head of private equity at Oaktree Capital, warns that unless private equity firms are prepared to put a lot more money into the companies they bought in a vastly different world “there will be the greatest transfer of ownership from equity owners to creditors in history”.