Public debt

Standard & Poor’s announcement that it is to publicly rate buyouts with total debt facilities above €1bn was welcomed by most as a positive development that could help kick-start the syndication market and restore investor confidence.

Publicly rating debt packages above €1bn will replace the current system whereby private credit estimates are provided for paying investors, which has been widely criticised as a major contributor to the drying up of liquidity. This system will remain in place for deals with debt facilities of €500m and below. Asked why this system has only been implemented now, Dominic Crawley of S&P said that ‘the market as it existed prior to the liquidity crunch was such that trying to instil greater discipline would have got less traction. The slow-down provided an opportunity to reassess the model.’

However, feedback by private equity on the planned changes has not been overwhelmingly positive, with some houses expressing concern that a move towards more formal ratings could impede the efficient market execution of transactions. Crawley says that there is a worry among large buyout houses that ‘publicly published ratings will provide credit benchmarks.’

This worry has been heightened over recent months with leveraged loans trading at wide discounts, often not reflecting the performance of the company and the ability of the borrower to repay the loan. In light of this, the reticence of the large buyout houses to fully support this new system is understandable.

However, Crawley believes that large buyout houses will come around to the new system when it proves a success. ‘Credit is top of investors’ priorities in a way it has not been in a long time and we expect that with the passage of time and shared experiences the concerns of the buyout houses will be allayed,’ he says.

Others have more fundamental concerns with the changes proposed by S&P.

As Ed Eyerman, head of European leveraged finance at Fitch Ratings says: ‘Ratings should be an opinion reflecting the information available on a public borrower as opposed to the sole source of information provided by a private borrower. If the private borrower does not have to report quarterly or report cash-flows yet the debt is publicly rated the danger is that investors will become too dependent on the rating agencies for information flow.’

Another danger is that this new regime will ingrain opacity within the system rather than compel investors, issuers and others to move towards greater transparency. ‘If sponsors want less expensive, more flexible debt options the obvious solution is to go to the broader capital markets for them. From 2005 to 2007, leveraged borrowers could get capital market pricing and terms on private debt because CLOs were in effect funded cheaply by monolines and SIVs. Sponsors will no doubt continue to prefer the private options, not least due to the refinancing and amendment flexibility.

He adds:'If the syndicated bank market, surviving CLOs and private investors like insurance, pension and sovereign wealth funds re-engage sponsors and offer private terms it will be difficult for investors or rating agencies to push sponsors towards the public markets and greater transparency, notwithstanding the broader market's desire for more transparency.'

A further consequence of S&P’s decision could be to hinder the ability of private equity firms to negotiate a route out of trouble when a covenant is in danger of being breached as it is more difficult to get a covenant waiver on publicly rated debt.

While on the face of it any measure that helps restore investor confidence and get the wheels of the syndication market moving again is a good thing, there is also good reason to be wary of jump-starting a market undergoing necessary corrections. As Eyerman cautions, S&P will publicly rate leveraged loan tranches above €1bn on the strength of the information provided by the private borrower and as such the ratings may not be the truest reflection of the strength of the credit and may give only an illusion of transparency.

S&P has made a brave move (albeit one which generates additional revenue in charges to issuers) and, if a success, could be the first step to a system of publicly rated leveraged debt on a far broader scale.

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• UK / Ireland