Awash In Debt, Private Equity Face $400 Billion In Payouts

New date from S&P LCD presented by the FT, shows that large private equity firms have $400 billion in debt that needs to be paid in the next five years. That debt load could be a drag on rising stock markets.

LBOs helped to fuel the frenzy of  rising publicly traded stock values in 2005 and 2006. Private equity firms would make a purchase of a large company in a major industry at a substantial premium and it would drive up values of all the firms in that sector. Ceberus put money into Chrysler and suddenly it appeared that GM and Ford were good investments. The buyout of Clear Channel briefly increased the perceived value of radio companies.

In 2006, over $550 billion in LBOs were announced in the US. The premiums paid for the companies involved almost certainly added over a trillion to the overall value of US stocks. Private equity firms collected hundreds of millions of dollars in fees to facilitate the transactions.

Banks believed that they would be the largest beneficiaries of the buyout trend. They made large loans to cover the purchase prices of deals arranged by LBO firms. The banks asked for and got high interest rates to finance the transactions. Bank managements supposed that a strong economy would allow the newly-private firms to pay back the loans with ease. The recession killed that possibility.

Private equity operations no longer have access to capital to offer premiums to buy large companies. They probably cannot even get money to acquire firms that would appear to be “cheap” based on their cash flow. The LBO industry may not come back in any meaningful way for years. In the meantime, major banks are left with loans, many of which are likely to default. It is yet another reason that America’s largest financial firms are not out of the woods.

Douglas A. McIntyre