"I ate his kidneys with some fava beans and a nice chianti."
Performance at the portfolio company continues to slip. It has breached bank covenants three quarters straight . . . what happens next?
Banks hate including an equity cure provision in their loan documents, but ironically the first thing they always ask for when things go off the rails is . . . an equity cure. During the boom an equity cure meant plugging a gap in quarterly EBITDA to bring the covenant calcs back into line, but sadly those days are well and truly gone.
Today what happens is this: your loan officer calls and assertively says "I think it's time we sat down and discussed the situation at Buggered Markets Pty Ltd." He appears firm and confident, but the truth is he's feeling pretty nervous. He underwrote that ridiculously large loan, and if it goes into default he has lots of explaining to do.
You discuss the weather and New Zealand's rugby prowess for twenty minutes, and then finally, "we feel it would be appropriate if the shareholders injected some capital to reflect the current performance of the business." By this he means: please, please, please pay down some of the senior debt so I don't get fired for lending money to your crappy company.
The key insight here is that the financial sponsors lending team is totally aligned with the private equity investor, not with the bank that employs them. If a loan defaults, they're in trouble too. And it's impossible for them to play the tough guy because their job is to sell more debt to the PE firm. They're worried about missing out on the next deal. No new loans, no big bonus. No big bonus, no sprawling holiday house in Noosa Beach.
The lending team will bend over backwards to cooperate with the PE firm and keep the evil credit guys at bay. The corruption varies from bank to bank, but I have watched lending officers turn a blind eye to outrageous profit normalisations and approve gymnastic variations to covenant calcs . . . anything to avoid a visit to the bad bank.
Next time: The Bad Bank. The PE firm just won't play ball. The General Partners have decided that this could be a case of throwing good money after bad, and refuse to inject any capital. What happens now?
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