Five Questions With… John Cobb, Partner, Milbank Tweed Hadley & McCloy

What new trends are you seeing in private equity financing?

We’re seeing a significant erosion of funding conditions in bank commitment letters. The market for LBOs has gotten so competitive. The sponsors often bring in a number of banks and create a competitive situation every time. They’re playing each of the banks’ terms and conditions off of one another and the result is that the banks are being forced to live with funding conditions that they never would have even considered a few years ago. For instance, you’ve seen the elimination of market max, significantly watered down business max, limitations on what reps and warranties they’re willing to make, [and imposing] requirements that the banks fund into certain defaults.

Is there anything else you’re seeing as it relates to contracts?

[Another] trend we’re seeing a lot of now has to do with the liquidity in the bank loan market or the leverage loan market. [We’re seeing] these covenant light deals where issuers are incurring bank debt but the covenants governing that debt are incurrence-based covenants rather than more traditional maintenance covenants. These are bank deals that are being structured in terms of covenants and are more like bond deals. You’re seeing a lot of that in the market now.

How has the job of attorneys changed in the wake of recent shifts in the financing market?

The biggest change relates to the fact that there’s a much broader array of financing sources being used to fund these LBOs. It’s no longer that if you’ve got leveraged loan and high yield capabilities at a law firm you’re a one-stop shop. You really need to be able to bring a number of different financing sources and expertise to these deals, such as securitizations, asset-backed loans and private placements. In addition, a lot of these LBOs have international components to them and you’ve got to be an international firm with capabilities globally.

How has Sarbanes Oxley changed the financing market?

It’s had an impact on the high yield bond market to an extent. We’ve seen some reluctance on the part of issuers and sponsors in smaller deals to go to the high yield market when there are other alternatives available. That’s in part due to not wanting to deal with the registration requirements and related requirements of Sarbanes-Oxley – particularly our smaller clients, smaller LBOs and foreign and Latin American issuers. … As long as the covenant light market and the bank loan market continues and there’s strength there, that’s another attractive alternative to the high yield market. You’ll see some movement to those areas, but I don’t think overall Sarbanes Oxley has had a huge impact on the high yield market.

What has been the impact of less risk-averse hedge funds entering the financing market?

There have been two impacts. The hedge funds have clearly provided additional liquidity in the market and that’s allowed more aggressive structures and has allowed sponsors and lenders to push leverage to greater levels. It’s allowed more aggressive overall financing packages in terms of covenant flexibility and the structure of the transaction. But on the other hand, a lot of these hedge funds – in addition to being sources of liquidity on the financing side – have also become competitors to the more traditional private equity firms. On that end they are making transactions more competitive and pushing up the multiples that these firms are paying for deals.