A loan too far

As the reign of the borrower continues apace, private equity houses have successfully extracted increasingly aggressive terms from their banks. But perhaps it is time to take stock.

Maybe sponsors should start thinking slightly less about the short-term quick fix and cast an eye towards the longer-term view. This is especially so as the ripple effects of the difficulties of hedge fund Amaranth have yet to play themselves out in the loan market (see p.15).

In general, the market has favoured either the banks or the borrowers; there has always been a balance of power one way or another. But lenient loan covenants with their unprecedented concessions, including equity cures that allow houses to put more equity in to stop them defaulting, and “double mulligan”, which allows a company to default twice before the bank can start default proceedings, has, according to one banker, “sent the balance way off kilter”.

The banks, of course, have been forced to enter into these agreements because they simply need to deploy cash in this ultra competitive and liquid environment.

“Normally, banks take the view that they have to have a fair amount of control but now they have to accept terms they would not have been prepared to do in the past and this is building up resentment – the pendulum has swung too far in the one direction,” says the banker. “The pressure on banks is extreme. They have got to lend the money with poor margins and unusual terms,” he adds.

But this situation will not last forever. The Amaranth debacle, for example, could affect the favourable lending terms enjoyed by the hedge funds in the loan market, which could in turn increase the competitive edge of the banks as the hedge funds look elsewhere to deploy their cash. If this happened, or simply if the market turned, the financial sponsors could be in for a rough ride.

“Banks have long memories and the sponsors have not made long-term friends,” says the banker. “The banks will extract their pound of flesh when the time comes as they claw back a position to the detriment of the sponsors. The sponsors are just in it for the money and cash return, and when the time comes and confidence decreases the banks will want to restore the balance.”

Even the lawyers have become wary of the consequences of this skewed power.

“We have to be very cautious when drafting borrower-friendly provisions in documents for the banks,” says one lawyer. “When the market turns, the banks could well turn around and ask us ‘Why did you put that in; why is that double mulligan clause included?”

“We have to be very sure that we have a clear record of why certain provisions were put in so that if something does go radically wrong and the banks ask ‘How the hell did that provision get in? Why did you allow that?’, we have made sure our backs are covered.”