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Private credit extracts tough terms from buyout shops lacking options

Private lenders extracted a large concession from one of the best-known leveraged buyout firms active in the technology industry this week when they demanded it stump up $1bn to help a portfolio company’s looming debts.

Lenders to Finastra, a financial technology company, required owner Vista Equity Partners to invest the extra $1bn into it in exchange for a $4.8bn loan the business needed to refinance debts coming due next year.

The deal is being looked at as a template for rival leveraged buyout shops as they contend with slower growth, higher interest rates and portfolio companies that may struggle to refinance debts maturing in 2025 and beyond through traditional capital markets. Vista was forced to turn to lenders in the burgeoning $1.5tn private credit industry instead of banks.

But as the new loan to Finastra demonstrated, while private credit is available to private equity groups attempting to keep their investments alive, lifelines will be expensive. In the case of Finastra, the six-year loan carries an interest rate of roughly 12.6 per cent, according to people briefed on the matter.

“The dynamic of private equity putting more capital into some of these capital structures, this is not the last of that,” said Michael Patterson, a governing partner of HPS Investment Partners. “This will be the theme for the time being. Private equity wants to retain ownership and have more runway to see a business through [a cycle].”

Finastra’s choice to turn to so-called direct lenders — investors who lend directly to a business, replacing a traditional bank — was driven by lacklustre demand in the bank loan market and the company’s own troubles. Asset managers such as Blue Owl, Sixth Street and HPS Investment Management have been competing with banks to lend to larger and larger businesses.

So-called collateralised loan obligations — the biggest buyers of riskier bank loans — have also slowed down their purchases. This is expected to push other private equity groups to private credit.

“Ratings are a huge issue for CLOs,” Craig Packer, a co-president of Blue Owl Capital, said. “The public markets are not nearly as flexible as it is perceived. Private lenders can do the diligence, make our judgment and take a long-term view.”

For months Vista prodded private lenders to come up with a multibillion-dollar loan to help refinance its existing debt, at each step seeking proposals that would allow it to avoid putting any new money of its own into Finastra.

But one risk kept floating to the surface: the company Vista bought in 2012 and expanded through a number of acquisitions, including a $3.6bn deal in 2017 that led it to be rebranded Finastra, was struggling to manage its debt load.

It may never have been a concern had markets not frozen after the Federal Reserve signalled its intent to aggressively raise interest rates. Deal activity collapsed and the number of initial public offerings plunged, making it far harder for private equity groups to sell off businesses they had acquired in the preceding years.

Buyout groups as a result are holding on to some businesses for longer than expected — and confronting debts that would have been managed by new owners after a sale.

Vista is not alone. Earlier this year KKR agreed to pump new capital into one of its portfolio companies, Heartland Dental, to help it refinance a portion of its debt. But the sheer scale of Finastra’s refinancing has captivated the market.

“Finastra will be a preview of the next three to five years ahead,” one person involved in the deal said.

Vista initially envisioned borrowing $6bn from private lenders to refinance Finastra’s debt. But difficulties emerged.

Lenders briefly pushed to split the loan into a senior and junior one. A tantalising yield of 12 to 12.5 percentage points over the floating rate benchmark — or roughly 17 to 18 per cent — was discussed for the junior debt, two people said. The high cost was seen as prohibitive and even then the company couldn’t round up enough interested lenders.

Refinancing was imperative, as Finastra had a loan and revolving credit facility that were set to mature in 2024. Most companies seek to refinance their bonds and loans at least a year before they come due to keep them from becoming current liabilities on their balance sheets.

As the summer progressed, Vista pushed lenders to keep pitching proposals that would keep it from putting in any extra cash. But it ultimately relented. Vista declined to comment.

“They started out trying to get more debt from the direct lenders, so it really shows appropriate credit discipline from the lenders,” one person involved in the deal said.

Blue Owl, Ares, Oak Hill, HPS Investment Partners, Oaktree and Elliott Management were among the investors that agreed to lend the $4.8bn this week. The loan will pay roughly 7.25 percentage points above the benchmark interest rate and was offered at a slight discount to par.

Vista, for its part, structured its $1bn investment as preferred equity, making the new money senior to Finastra common stock.

Private equity sponsors have other options and many are loath to pump extra cash into an investment that is struggling, particularly when it was purchased from an older fund that may be winding down.

Many have gone down the path of distressed debt exchanges, where a company offers to give its creditors new bonds or loans worth less than the outstanding ones in exchange for more seniority in the capital structure. Others may choose to throw in the towel altogether, as private equity firm KKR did when its Envision Healthcare filed for bankruptcy earlier this year.

“It’s on the sponsor to defend their portfolio,” said John Kline, managing director of New Mountain Capital. “Sponsors will make rational decisions to support their great assets and they won’t let a small amount of interest expense or leverage get in the way of the future of business. They might not defend poorly performing assets.”

Some are holding out hope that public markets will rebound, opening the door to a much wider pool of buyers of high-yield bonds and leveraged loans. There are signs that it is already happening, with JPMorgan Chase and Goldman Sachs lining up $8.4bn of debt to fund GTCR’s purchase of a majority stake in payments provider Worldpay. That debt will eventually be sold on to buyers of risky loans and bonds.

The difference, lenders and investors noted, was that recent deals reflected new financial conditions, with growth and interest rates that few buyout groups were considering when signing deals between 2018 and 2020. As a result, debt levels are being managed more conservatively.

That is not the case for deals that buyout firms hold from an earlier era.

“Issuers with weaker credit quality and near-term maturities may be attracted to private credit,” said Christina Padgett, head of leveraged finance at rating agency Moody’s. “Private credit lenders have a higher tolerance for risk which is mitigated by a strategy that includes the potential for an equity contribution from the private equity owner.”

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