Percentage of Problem Loans for Private Equity Buyouts Tripled Over Past Year

Here is a look at a story from last week that didn't receive as much credit as it should've, as everyone's attention was on last week's market crash:

(From the FT): "The percentage of large syndicated US loans rated as problematic has nearly tripled in the last year, highlighting the damage done by the lax underwriting standards of the private equity boom, a report by US regulators showed on Wednesday.

During 2006 and early 2007, leading banks competed fiercely to lend to private equity groups, often dispensing with the usual covenants meant to secure such credits in a development that led to the so-called “cov-light loan”.

The annual federal “shared national credits” survey - which examines credit commitments of more than $20m held by three or more banks - found that $373.4bn of such loans faced actual or potential difficulties at the end of the second quarter.

That was an increase of $259.3bn from the total of “criticized” loans during the previous year. Such problem credits accounted for 13.4 per cent of the total held by lenders in the US, up from 5 per cent the previous year, the survey showed.

The report by banking regulators including the Federal Reserve said many of the loans in the “criticized” category could migrate to more severe classifications, suggested default risk is increasing.

So-called “classified” credits - rated as substandard, doubtful, or loss-making by the regulators - rose 128 per cent to $163.1bn, or 5.8 per cent of the total, up from 3.1 per cent in 2007."

The most obvious implication here is that the bad lending standards in the private equity space undoubtedly had an effect similar to one seen in the housing market: easy access to money inflated asset values, and fed speculative and overly exuberant behavior. The sudden surge in defaults indicate that many of the deals done in '07 and '06 simply aren't generating enough profit to service the debt used to finance the buyout, and while the economic downturn is a factor it doesn't change the fact that many PE firms simply overpaid.

I.e. the buyout craze had many firms overly focused on simply closing "a deal", as opposed to closing a "profitable or smart deal", because I'm sure that even without an economic downturn many firms would still be looking back and realizing that they paid too much.  

Overall this situation is just another example of how bad lending standards were a problem across many types of loans not just mortgages and other types of consumer loans, and  how on a go-forward basis all credit users (be they corporations or consumers) are going to have to adjust both their habits and their expectations with regards to credit.

You can read more here.

Sources

The Financial Times: "Problem loans nearly triple in the US" -- Julie MacIntosh, Franceso Guerrera and Joanna Chung, October 8, 2008.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.