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Private equity firms cherry-pick buyers for loans

When Unilabs, the Swiss medical diagnostics business owned by private equity firm Apax, sought buyers to refinance its loans this month, it was by invitation only.

The decision to restrict who could buy its loans, while also cutting typical investor protections, is a classic sign of a red-hot credit market in which private equity owners are emboldened to sideline investors who will be more demanding should a buyout target fall into stress.

Advent International, Bain Capital, Bridgepoint and CVC are among the other firms which in recent months have struck names off so-called white lists that spell out the approved buyers of loans, according to more than a dozen interviews with investors, bankers, lawyers and private equity principals.

“We saw this in 2006 and 2007. We saw it 1998 and 1999,” said John Bolduc, who runs HIG Capital’s credit business. “It is a sign of a hot market . . . where there’s more supply of money than there is demand so the borrowers can demand relatively egregious terms.”

While culling white lists offers long-term benefits to private equity firms seeking to fund or refinance deals, it could cost money managers dearly when the economic cycle turns.

In particular, excluding competing private equity firms and distressed investors, who specialise in the credit of companies facing financial hardship, removes people who would be natural buyers in a period of turmoil that might only emerge years from now.

“If that distressed investor is not there, that can cause greater price moves because a potential buyer has been removed,” said Steven Oh, head of credit at asset manager PineBridge.

Apollo, the Wall Street investment firm run by billionaire Leon Black, and Oaktree, co-founded by Howard Marks, have both been targeted as the lists are culled, according to people with knowledge of the matter. Dozens of other investors have also been quietly dropped, including Canyon Partners, Angelo Gordon, Black Diamond and HIG Capital, bankers and investors said.

Mr Bolduc said the firm had not been impeded from conducting any transaction because of a white list.

Advent, Apax, Bain, Bridgepoint and CVC declined to comment. Apollo, Oaktree, Canyon Partners and Angelo Gordon also declined to comment. Black Diamond did not respond to multiple requests for comment.

White listing has been focused on Europe, where a shortage of new leveraged loans last year drove up competition between investors and spurred private equity firms’ actions. S&P’s index of European leveraged loans hit a record high in February and is up more than 5 per cent over the past year. Over the past three years it has climbed nearly 15 per cent.

Changes to white lists often target an investment firm’s specialist distressed funds, while allowing its other funds to buy the loans. However, there have been caseswhen an entire firm has been excluded, often when the private equity owner has had difficult dealings with the investor in the past, several bankers and investors familiar with the white lists say.

Tightening up white lists is not the only way in which private equity firms are flexing their muscles in a buoyant market.

Since the financial crisis, documents governing how loans can be traded have typically stated that PE-controlled companies could not “unreasonably withhold” their consent if an investor seeks to sell the loan on.

The documents have also typically set an explicit timeline for a private equity firm to object to such a sale before it could be completed.

Now some deals, including the loans issued by Unilabs last week, are tweaking or removing such language altogether.

Private equity firms have also started to chip away at banks’ ability to transfer the risk of a revolving credit facility or term loan to other investors, known as sub-participation. Investors and bankers added that loans issued by Advent-backed licence and identity card maker Oberthur, which also restricted its white list, took aim at sub-participation and transfer rights.

“I tear my hair out,” Bill Wolfe, a credit analyst with Moody’s, said of the general weakening in protection for investors. “How do you negotiate anything now? Credit agreements are becoming one page.”

Investors have not forcefully pushed back at the more restrictive terms, despite the subtle shifts making their way to a growing list of transactions.

However, several investors, who feared being left out of a future transaction if they spoke on the record, warned that pruning the lists of buyers could undermine future trading and liquidity in the loans if a company falls into distress.

“They [investors] will not realise they cannot get out until it is too late,” said a banker involved in the transactions. “They will realise they are in the roach motel and can’t get out.”

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