PetSmart Said to Lower Rate on $4.3 Billion Loan Backing LBO

PetSmart Inc. reduced the rate on a $4.3 billion loan it’s seeking to fund its $8.7 billion buyout by BC Partners, signaling investors are ready to embrace a deal that may not meet regulatory guidelines.

PetSmart reduced the interest rate being offered on the loan to 4.25 percentage points more than the London interbank offered rate, from an originally proposed range of 4.5 percentage points to 4.75 percentage points, according to a person with knowledge of the deal, who asked not to be identified because terms are private. Investors are being asked to commit to the deal by Friday, the person said.

The leveraged-buyout financing comes amid slumping issuance and fading demand for such loans, and is poised to be the largest in the speculative-grade market for bank debt this year. Standard & Poor’s and Moody’s Investors Service have estimated the LBO will push PetSmart’s debt above six times a measure of earnings. That’s a level the Federal Reserve and the Office of the Comptroller of the Currency said raises concern when they updated their leveraged-lending guidelines in 2013 for the first time in more than a decade, seeking to improve Wall Street underwriting standards for high-yield, high-risk loans.

PetSmart is “the real first test of the market in early 2015 for a highly levered deal,” David Kreidler, a New York-based loan product manager at S&P, said in a phone interview. “It will set the tone.”

Bryan Locke, a spokesman for PetSmart who works at Sard Verbinnen & Co., declined to comment on the LBO financing.

‘Criticized Loan’

Moody’s estimated in a report this week that the buyout financing would push PetSmart’s debt to as high as 7.25 times earnings, leaving PetSmart with nearly $450 million of cash interest expense over the next 12 months. The company also plans to issue $1.9 billion of notes to help fund the buyout. The retailer is rated four levels below investment-grade by both Moody’s and S&P.

“Some potential lenders have expressed concern that regulators may classify PetSmart as a criticized loan,” S&P’s Kreidler wrote in a Feb. 11 report.

Citigroup Inc. is the lead arranger of the buyout loan for PetSmart, according to data compiled by Bloomberg. Robert Julavits, a spokesman for the bank, declined to comment.

Leverage Multiple

Moody’s analysts led by Michael Zuccaro said in their Feb. 10 report that they expect PetSmart to cut its leverage below six times earnings within 18 to 24 months after the buyout closes due to strong free cash flow.

Total debt used to finance large LBOs climbed to 5.9 times earnings in 2014, from 3.9 times in 2009, according to the S&P report. “It’s likely that senior debt multiples will continue to rise in 2015, despite warnings from regulators,” Kreidler wrote in the report.

The $10.9 billion of leveraged loans issued this year is down 86 percent from sales to institutional investors in the similar period last year, Bloomberg data show.

The amount of principal recovered from 2009 to 2014 by investors in first-lien loans that defaulted averaged 87 percent in deals where there was at least 20 percent of junior debt financing such as bonds, according to the S&P report. Without that cushion, recoveries were just 72 percent, the report shows.

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