I hate private equity firms with a passion. They often buy a company using deals paid for primarily with leveraged loans borrowed by the companies they acquired. Then they strip the company and run it into the ground. Toys’R’Us is only one of many examples.
Leveraged buyouts (LBOs) hit a record of about $1 trillion last year. The S&P/LSTA Loan Index, broadly used as a proxy for market size in the U.S., totaled some $1.375 trillion at February 2022, the most ever.
https://www.spglobal.com/marketintelligence/en/pages/toc-pri…
A lot of this debt is floating rate – it’s based on LIBOR plus a set percentage. As interest rates rise, the interest on the debt can bankrupt companies that are already weak. These are junk bonds that were sold when interest rates were stable. But interest rates aren’t stable anymore so the interest payments owed on these leveraged loans will rise.
https://www.wsj.com/articles/rising-rates-threaten-companies…
**Rising Rates Threaten Companies Acquired in LBO Boom**
**Floating-rate debt protects lenders from Fed rate increases but can lift expenses for borrowers amid rising inflation**
**By Matt Wirz, The Wall Street Journal, April 20, 2022**
**....**
**Companies with heavier debt loads can find themselves running short on cash if their interest rates climb alongside wages and other operating expenses. ...U.S. companies borrowed $1.8 trillion in junk-rated loans in 2021...**
**The benchmark rates that most leveraged loans are priced off are expected to rise to around 3% in the next 12 months, up from about 0.50% now, according to Citigroup research. That equates to a $45 billion interest-expense increase on the loans that were issued in 2021 alone...**
**Cash flow for most borrowers is about 3½ times their interest expense, according to research by Bank of America, but about 15% of the market generates about 1½ times their interest cost.** [end quote]
This gets down to the nitty-gritty of reading financial statements before buying a stock.
Cash flow is king.
If a company can’t generate the cash flow to cover their interest payments they are at risk for default and bankruptcy. In that case, the owners of the debt would get stiffed, but that’s not likely to be any METARs. However, the stock price would crater…and METARs might own some of the stock.
METARs who own individual stocks, especially “high growth” Saul-type companies that might have borrowed a lot, should check the cash flow to interest expense ratios. Also, check to see the ratings of their debts and whether any of it is floating-rate leveraged loans. (That info might not be available on SEC filings.)
Wendy