The multiple of leveraged buyout (LBO) debt to earnings has hit 5.8, the highest it has been since the financial crash, according to LCD/S&P.
A debt level of six times earnings has historically been regarded as high-risk territory.
“Covenant-lite” leveraged loans remain at an elevated level, too.
But private equity appears to be putting more of its own cash at stake in LBO deals, and the extreme end of the market has moderated. People are tapping the brakes, in other words.
The Trump administration is taking a relaxed approach to the whole thing.
A key indicator of danger at the risky end of the corporate credit market is creeping toward a hurdle that the US government used to regard as too high, according to data from the Leveraged Commentary & Data unit of S&P Global Market Intelligence.
Last year, the multiple of leveraged buyout (LBO) debt to earnings hit 5.8, the highest it has ever been since the financial crash, according to LCD/S&P, a research organisation which monitors the corporate debt market.
A debt level of six times earnings has historically been regarded as heading into high-risk territory. Above that, US government regulators start to ask whether companies are taking on more debt than they can possibly pay back.
The multiple is a comparison of debt incurred in a leveraged buyout of a company compared to its earnings before interest, taxes, depreciation and amortization (EBITDA). In 2014, in a speech to bankers about whether he wanted to see corporate loans go over six-times earnings, Federal Reserve official Todd Vermilyea said, “No, no, no, no, no.”
In theory, the fear is that investors might stop believing that companies with this type of high-multiple debt are capable of paying it back. If that happened, the supply of cash to fund those debts would dry up, and the companies who depend on it would face bankruptcy. It’s not clear how many companies are dependent on credit generated in LBOs. But between 12% and 16% of all companies globally are dependent on corporate debt of a similarly poor quality to that issued in high-risk LBOs.
Back to 6X leverage
The LBO/EBITDA multiple last went over 6X in 2007.
Today, it stands at 5.8, the second-highest level ever, according to S&P.
The Trump administration has taken a relaxed approach to the 6X level. Joseph Otting, Trump’s comptroller of the currency, told bankers last year that 6X was just “guidance.” “You have the right to do what you want as long as it does not impair safety and soundness. It’s not our position to challenge that,” he said.
Leveraged buyouts are among the riskiest type of debt deals in the corporate credit market. Typically, they might involve a private equity firm offering to buy an underperforming company using borrowed money. The new owners then use the money to restructure, tear apart, or rebuild the company before selling it on, hopefully at a profit. Lenders receive extra-high interest payments on their money because the risk of failure is comparatively high. The LBO was glamorized in movies …read more
Source:: Businessinsider – Finance