Buyouts/portable loans: mind your language

Famed hedge fund manager Ray Dalio has argued “cash is trash” when businesses hold on to it. But the pandemic has challenged his line of thinking. Piles of cash are now an industry advantage. US-based buyout groups have nearly $847bn of dry powder, according to data provider Preqin. This has given them unprecedented negotiating power, as demonstrated in the growing portability of buyout loans.

Private equity groups have started inserting so-called “portability language” into documentation. These clauses allow issuers to bypass change of control covenants. Features of high-yield bonds, they were previously rare in the loan market.

Traditional loans feature a change of control provision that requires the debt to be paid off at par when a company is sold. If debt is distressed, the holders are still recompensed at 100 cents in the dollar, perhaps more for bonds where there is a make-whole provision.

This explains why private equity firms had a hard time finding buyers for energy groups this year when oil prices collapsed. Any sale would require all that debt to be refinanced — which would have been next to impossible given market conditions.

By making debts in portfolio companies portable, and therefore transferable to the new owner, private equity firms make it easier to secure a lucrative sale. That pushes extra risk on to lenders. The job of servicing borrowings falls to an unfamiliar management team with a different business plan.

Portability also means less business for banks — fewer fees are involved when debts are transferred. So some complaints against portability are self-serving.

They have an impotent ring. Regulators have been keeping a tighter lid on leverage since the financial crisis. But ultra-low interest rates have made it easy for private equity to extract other concessions from lenders. Banks have already cut pricing and relaxed other covenants. Portable loans are a further step in the same direction.

The trend underlines the emergence of alternative asset managers as power houses akin to pre-crisis investment banks. Buyout companies are now equally adept at exploiting market power and asymmetries of information to tilt terms of business in their favour.