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Equity Firms Buying Debt?

I was recently asked if the current credit mess would force certain private equity firms out of business — like what’s happening in the hedge fund world. I responded negatively, because private equity firms typically don’t actually hold the leverage on their deals. That’s on the banks and anyone the bank was able to syndicate out to (i.e., the troubled hedgies). In fact, one could make a strong case that private equity was not a “high-risk” asset class over the past 18 months.

But now some private equity firms are changing course, and buying up buyout-related loans from sponsor banks. I mentioned this briefly in yesterday’s PE Week Wire, and The Deal today paints a fuller picture.

Banks are pitching these swap facilities as a way for large private equity firms to disburse fund capital, at a time in which its very difficult to secure loan commitments for new transactions. And the aforementioned article cites Apollo as a particularly active participant, having picked up a “large chunk” on the bonds related to Apax Partners and Omers Capital Partners’ $7.75 billion buyout of Thomson Learning.

This is all being done at steep discounts, of course, and requiresthe banks to swallow some serious pride. Imagine being forced by KKR to honor lousy debt commitments on one deal, and then begging KKR to buy discounted debt on another hung bridge at a deep loss. It’s like buying rounds for a bar full of guys sleeping with your wife.

So obviously an interesting trend, although I’m not sold that it will be as prevelant as The Deal suggests. First (as the article acknowledges), many PE firms will actually have to secure new leverage to close these deals. And since the dearth of new leverage is what’s causing cabin fever in the first place…

Second, these deals are also predicated on the notion that LBO firms are swimming in dry powder. It may be true for some firms, but not many. Blackstone this week acknowledged that it’s already committed two-thirds of its new fund, while other firms (Bain, KKR, Madison Dearborn, etc.) are running so low that they’re either raising new funds or securing extra commitments for existing funds. In other words, the demand might not be as severe as the banks hope it is.

There’s also the question about how much LPs would appreciate their private equity funds buying up debt packages…