Breakingviews
August 8, 2022

Breakingviews: Private equity needs more other-people’s-money

by Breakingviews.

For the likes of Blackstone and KKR, equity and debt go together like peanut butter and jelly. Buyout firms are sitting on $1.4 trillion in cash, but in order to do deals, they need leverage with which to pair it. There aren’t many places for them to find it, at least not in the quantities they might wish.

When Steve Schwarzman’s private equity lieutenants at Blackstone, or their peers, want to buy a company, they typically pair a wad of cash provided by their fund investors with debt. That allows them to target bigger acquisitions, and increase the returns to their equity investors and themselves, by paying down the debt as quickly as possible from the acquired company’s cash flows.

But the syndicated loan market, where bank loans backing private equity deals are parceled up and passed around, has slowed sharply. Deals supporting highly-indebted mergers and acquisitions totaled $46 billion in the second quarter, down by 52% from the same period in 2021, according to Refinitiv. The market has sagged as investors grapple with rising interest rates and banks try to offload loans made before the market soured.

Direct lenders – who pool private money, lend to deals and keep hold of those loans – can take up some of the slack. After growing rapidly, they now regularly support big buyouts. Direct loans typically cost more than syndicated loans but are faster and can be offered in situations where banks dare not tread.

The catch is that the two debt markets are interlinked. A borrower can take out a direct loan, pay it down until public investors would find it acceptable, then refinance it in the syndicated market after a couple years to get a cheaper interest rate. The direct lender can use that repaid money to immediately fund new deals. But syndicated refinancings for leveraged loans were 41% lower in the first half of 2022 than a year earlier, per Refinitiv.

Private lenders who have money to invest can thus cherry-pick the best deals. But those who don’t have money may struggle to get more. The amount of private credit funding raised, while similar to a year ago, is running a third below its peak in late 2021, according to Preqin. Private equity might be ready to put its vast reserves of cash to work. But without ample debt, much of that so-called dry powder might have to stay dry.

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