Complex debt structures thing of the past?

The credit crunch is sending private equity back to basics both in terms of investment choice and debt channels, according to new research published by Grant Thornton and Latham & Watkins.

In a survey of 110 senior lending bankers, CLO providers, hedge funds and private equity executives in the UK and Europe, the use of traditional senior and subordinated debt was predicted to rise by 50% and 58% of respondents respectively. Conversely, the more complex and risky debt structures, including payment-in-kind (PIK) and covenant light (cov-lite) arrangements are predicted to lose popularity as quickly as they have gained it.

David Ascott, head of private equity at Grant Thornton, said it was a case of many private equity houses reverting to a more risk averse strategy, in which complex debt structures that had been created and used with increasing frequency over the past 18 months were being put on hold due to market illiquidity.

Seventy-one percent of those surveyed predicted the number of PIK arrangements to fall, while an overwhelming 85% predicted a drop in cov-lite deals. In terms of where debt was to be raised, senior lenders were back on top, followed by hedge funds and second lien lenders. CLO providers, on the other hand, were expected to figure less in the debt raising environment by 80% of those surveyed.

Deal size was also in back to basics mode, with private equity set to shy away from the public-to-private deals that had grabbed headlines in the early part of 2007, according to 64% of industry respondents. In terms of deal size, there was also the prediction that the smaller deals would fare much better, with only 7% of those surveyed predicting problems for small cap deals.

Ascott said for many private equity firms, the next 12 months was set to be a time of consolidation.