The New York Times DealBook blog has another interesting post on the debt being used to finance private equity deals. This one is entitled "Is Private Equity Riding A Debt Bubble?" It discusses a recent article in the Boston Globe which, among other things, quotes the CEO of a major private equity firm as using the term "debt bubble" to describe the current situation in the debt market.
The Boston Globe article points to low interest rates, large loans relative to the acquired company’s cash flow, and the lack of covenants — sometimes known as "covenant lite" loans — as driving the phenomenon. Some deals are also being structured with so-called toggle notes, giving the borrower the option to make "payment in kind" or PIK payments — additional debt instead of cash — although at a higher interest rate. The absence of significant covenants led the quoted CEO to ask, "How do you default?"
This DealBook post follows one from last week, reported here, discussing the rising risk level of the debt behind private equity deals. If these generous lending terms are putting us in a "debt bubble," would an economic hard landing burst the bubble and lead to even more defaults, restructurings, and bankruptcies? Time will tell.