Private Equity’s lending safeguards deteriorated
Between about 2018 and 2021, I heard from a lot of debt investors who were unhappy about what they were being asked to swallow in the booming market for financing private-equity deals.
Ambitious lawyers — even more than sharp-toothed dealmakers — were driving the degradation of lending standards, providing less protection if a borrower went south.
Many managers felt powerless to fight it: They needed to put money to work because sitting on cash pays nothing.
As ultra-cheap money drove a manic hunt for yield, debt investors competing for a piece of new deals accepted ever-weaker safeguards in loan contracts. These are the covenants and secure claims to collateral that help lenders recover their money when overleveraged businesses get into trouble.
Now is the time to start regretting this behavior.
It’s a classic agency problem: A conflict between, on the one hand, the ultimate investors in the funds or vehicles that buy the loans and, on the other, the managers of those funds and CLOs.
When a manager is forced to buy whatever assets they can get, they can’t be acting fully in the interests of investors, which at the end of the line is you and me through our pensions, mutual funds, or insurers.
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