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Covenant lite debt bubble fuels private equity

Date: 4th May, 2007   |   Author: Chris Laughton   |   Comments: 0

The New York Times DealBook blog reports a Boston Globe article interviewing private equity firms TA Associates and Thomas H. Lee Partners (thanks again to Bob Eisenbach for flagging this here). The article reinforces the view we expressed in an earlier post that lax credit standards could magnify default rates in an economic downturn. A private equity investor borrowed at 2.25 per cent over LIBOR. When the target investment defaults, the investor can "toggle" its loan repayments into "payments in kind", borrowing more from the lender (at a 0.5 per cent interest premium) to make loan repayments. No real penalty for loan default then - hence, "covenant lite"! This shouldn't be a problem when the odd investment defaults, but it makes a hard landing more likely than a soft one when the economy turns. Do you think the debt bubble is encouraging private equity to store up problems, or is there enough liquidity in the system to weather any run of defaults? Let us have your comments.

 

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