Leveraged loans are getting expensive, robbing the buyout boom of Momentum


The debt-fueled takeover boom is running out of steam, with attractive funding for LBOs becoming harder to come by.

After years of taking advantage of low-cost debt, private equity firms are finding it more expensive to obtain funding in the leveraged loan market, the source of most capital than most. they use to fund buyouts. The average yield to maturity of loans backed by new leveraged buyouts has risen from around 5% last year to 5.7% so far this year, according to Leveraged Commentary & Data. Federal Reserve plans to keep raising interest rates threaten to make debt even more expensive.

As a result, some private equity firms are choosing not to make offers for companies they were considering or are looking to close deals using more equity, according to dealmakers and their advisers. Some banks, for their part, have chosen to abandon financial arrangements for fear of not being able to discharge loans to investors.

The volume of leveraged loans, after a torrid January, has slowed significantly as the Fed raises rates to curb inflation and stocks trade well below past highs. Through May 25, companies have issued some $51 billion in leveraged loans to fund private equity buyouts this year, up from about $65 billion in the same period last year, according to LCD data.

Market turmoil weighed on leveraged buyout activity. So far this year, $373 billion in private equity deals have been announced in the United States, including sales and purchases, compared to some $570 billion in the same period last year, according to Dealogic.

A number of potential big deals in the works that have yet to be agreed are in play. Possible targets include software company Zendesk Inc.

and Walgreens Boots Alliance Inc.

Boots retail pharmacy chain.

“It puts a lot of pressure on getting new deals done,” said Jeffrey Ross, partner at law firm Debevoise & Plimpton LLP, of the slowing funding market. He works with companies such as Carlyle Group Inc.,

GPT Inc.

and Clayton Dubilier & Rice LLC for financing their transactions.

Lenders typically distribute leveraged loans to institutional investors such as secured loan bond managers and mutual funds, as well as other banks. (Many of the larger CLO managers are managed by the separately managed credit arms of the private equity firms themselves.)

Borrowings are inherently risky as they are often contracted by heavily indebted companies; this risk is heightened in times of economic uncertainty such as this.

The market was operating at a brisk pace. In 2021, $146 billion in leveraged loans were issued for buyouts, the most since 2007. And last year was the biggest ever for private equity deals done, with a volume of new purchases, asset sales and add-on transactions exceeding $1 trillion, according to Dealogic.

In January of this year, loans were made for deals such as the $17 billion deal struck by Bain Capital and Hellman & Friedman LLC to privatize health technology provider Athenahealth Inc., which required a loan term of nearly 7 billion dollars. Additionally, a consortium including Advent International Corp. and Permira bought cybersecurity provider McAfee Corp. in a roughly $12 billion deal that required some $5 billion in leveraged loans.

Last month, by contrast, only $2.2 billion in leveraged loans were earmarked for buybacks, the smallest amount since July 2020 excluding the typically slow December period, according to LCD data.

Unlike Europe, where the syndicated loan market has been largely closed since Russia’s invasion of Ukraine in February, investors can still close deals in the United States if they’re willing to pay higher prices.

This is partly due to the proliferation in recent years of private credit funds, which do not have to syndicate debt and can provide capital from dedicated vehicles backed by investors willing to do so. The decision to privatize Zendesk, if it materializes, would likely depend heavily on private credit providers financing what could be one of the biggest LBOs of the year, according to people familiar with the deal.

Indeed, private credit has been behind some of the biggest deals announced so far this year, including the $10.4 billion purchase of software company Anaplan. Inc.

Large private lenders such as Blackstone Inc.

credit arm, Blue Owl Capital Inc.

and Ares Management Corp.

will likely continue to take market share from banks as the turmoil sets in, market participants say.

Private credit is generally more expensive than a traditional loan, but offers more certainty and stability in pricing.

Write to Laura Cooper at laura.cooper@wsj.com

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