Private equity’s biggest names including KKR and Bain Capital are handing over distressed companies to the lending arms of rivals, as they struggle with tough economic conditions.
The rash of handovers to creditors underscores the problems many private equity firms face as their portfolio companies contend with higher interest rates, stubborn inflation and supply chain issues.
It also shows the growing influence of credit provided by the lending arms of the same large private equity firms. In recent years, private credit has been a faster-growing business than buyouts for many of the industry’s biggest names, including Apollo, Carlyle and KKR.
Bain Capital’s European business has recently ceded ownership of German manufacturer Wittur to KKR’s credit arm, according to people familiar with the deal.
Goldman-backed ink supplier Flint is also in talks with creditors about handing over control, according to several other people familiar with the details, while Carlyle is expected to hand over the keys at security company Praesidiad to a group of lenders including Bain Capital’s credit business.
Meanwhile, KKR’s private equity arm has lost control of German payments company Unzer to a group of creditors including Goldman Sachs, Swiss private equity firm Partners Group and European credit manager Alcentra.
In the US, KKR’s investment in healthcare company Envision was wiped out in a deal for a group of senior lenders including Blackstone to take over the company, the Financial Times reported in May.
“We had many years of easy money and low interest rates where companies owned by private equity took advantage,” said Jeanine Arnold, an executive at rating agency Moody’s.
“[Private equity] continued to push the boundary on the debt those companies were taking on. That’s OK when you have earnings growth but then we’ve had Covid, Ukraine and interest rate increases.”
Private equity-owned businesses are struggling partly because some of the debt used to finance buyouts was not hedged against interest rate rises.
As rates have gone up, loan repayments have increased and companies have had to spend more money servicing their debt.
“There was relatively little interest rate hedging by private equity firms for their floating rate debt and now that rates have gone up, debt servicing costs have more than doubled over the past year and a half,” said Paul Goldschmid, partner at investment manager King Street.
A problem for lenders is that many of the loans that were used to finance the deals do not have strong covenants, contractual protections for creditors, which can help them identify issues with a company’s balance sheet before it runs into serious problems.
“The key difference we see between now and the last cycle is that the trigger event now tends to be liquidity, given the lack of covenants during the last few years,” said Manuel Martinez-Fidalgo, a co-head of restructuring at Houlihan Lokey. “In 2008 or 2010, you would sit down and have an early seat at the table. That isn’t the case now.”
Adam Plainer, co-chair of Dechert’s financial restructuring group, said: “The warning signs aren’t being picked up early enough.”
The loose lending terms give private equity owners more flexibility to come up with solutions to keep their companies afloat, including taking on more debt.
“The nature of the loans created over the past few years allows the issuers to kick the can down the road as there are very few protections for existing lenders,” said Dushyant Mehra, co-chief investment officer at hedge fund Hildene Capital Management.
If there are a series of company defaults it could leave creditors with losses, as well as the logistical headache of having to own assets they did not intend to.
“For now, there is an alignment in incentives between private equity and private credit,” said Allan Schweitzer, portfolio manager at credit hedge fund Beach Point, which manages $15bn in assets. “Private equity firms want their portfolio companies to keep going, and private credit firms don’t have the infrastructure to take the keys of multiple companies simultaneously.”