Worried About Next LBO Loan Bubble? Private Equity Has Your Back

  • Equity checks remain one backstop in frothy U.S. debt market
  • S&P warns borrowing binge is recipe for 2007-style downturn

As safeguards and margins melt away on leveraged loans, there’s one quantum of solace: LBO firms are contributing as much equity to U.S. acquisitions as they have over the past three years.

Despite seemingly endless appetite for high-yielding debt and tolerance for shrinking margins and safety cushions, private-equity firms have maintained their average contribution, or checks, to leveraged buyouts. The enduring equity stakes may offer an anchor to keep struggling companies afloat if the business cycle turns.

It’s a constant in a market facing warnings it’s on a cliff edge.

2007 again

“The risks of this debt binge are significant, given that excessive leverage can bring down a company as fast as prudent borrowing built it up,” S&P Global Ratings warned in a report last week. The build-up of debt has left U.S. companies “as vulnerable to downgrades and defaults as they were in the run-up to the 2007-2008 global financial crisis.”

Even as risks multiply, lenders are accepting ever-falling margins, especially for covenant-lite loans. Investors are charging less for deals that lack covenants than those that limit additional borrowing, according to data compiled by Bloomberg -- suggesting traditional safeguards are often treated with suspicion.

Still, debt excesses appear to have passed their peak, according to S&P. The ratings firm estimates leverage at U.S. speculative-grade firms will fall to less than five times in 2018.

— With assistance by Neil Denslow

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