Bankers. hungry for high-yielding loans, are loosening their lending standards for leveraged buyouts and recapitalizations.
For one thing, amortizations are getting "back-ended," meaning the bulk of the repayments are coming in the later years of the loan.
Banks are also becoming more liberal about debt and interest-coverage ratios and are requiring less equity in deals that they help finance.
"All of your leverage indices are getting a little more aggressive." said Thomas Bunn, head of loan syndications at Nations Bank Corp. in Charlotte, N.C.
Deal firms have taken notice.
"We saw how Specialty Foods got financed, and wondered how it cleared the bank market." said John Muse, partner at the Dallas buyout firm Hicks, Muse & Co.
Mr. Muse was referring to a collection of specialty food brands being acquired by Texas billionaire Robert Bass and other investors for over $1 billion.
Loans, Junk, Debentures
The buyout is being financed mainly with bank loans and junk bonds, including $319 million of discount debentures, which are a form of so-called interest-deferred securities.
Widely used - and abused - in the 1980s. interest-deferred securities enable borrowers to postpone interest payments for a number of years.
Detractors view the securities ticking time bombs on a company's balance sheet.
Even some members of the bank group backing the Specialty Foods deal describe it as an aggressively capitalized, 1980s-style buyout. Chemical Bank is lead bank on the $540 million loan.
Banks Get Paid First
The bank debt is scheduled to be paid off before the discount bonds start paying interest and principal, which is one reason why the banks went along with the deal.
But even as recently as six months ago, that might not been the case.
Indeed, the gradual reappearence of interest-deferred securities in buyout financing is a further sign that the deal mark could be on the verge of overheating.
So far this year, $3.8 billion of deferred-interest securities have been offered in the public junk bond market. compared to just $1.59 billion in the first eight months of last year, according to Securities Data Co. More of these high-yielding surities have also been sold in the private placement market.
Interest-deferred securities take various forms. Payment-in-kind, or PIK, securities initially pay interest in the form of additional securities. Zero-coupon bonds, sold at deep discount to face value, pay no interest until maturity, when the bonds are redeemed at face falue.
Some discount bonds start out as zeros and then begin paying cash interest after several years.
Investors purchasing such securities gamble that the borrower either will be better able to pay back the debt in the future, or will sell off assets to cover payments.
Not Panning Out
As recent history shows, such bets often failed to pay off.
Roughly 25% of the 230 issuers that defaulted on bond payments in the past three years were companies that had undergone a leveraged buyout, and many were financed in part with interest-deferred securities, said Jerome Fons, an economist at Moody's Investors Service Inc. a major bond-rating agency.
Indeed. the bankruptcy courts have been littered in recent years with cases involving companies that loaded up on these securities.
In recent months, investors in the junk bond market appear to have brushed aside any concerns about the risks associated with these securities, as they scramble for higher yields in today's low-interest-rate environment.
A Red Flag
No matter how you slice it, financing a buyout or recapitalization with the help of these securities signals that the deal does not work based on the borrower's historical cash flow, said Joseph Rizzi, senior vice president for structured finance at Dutch-owned ABN Amro Bank in Chicago.
"We really look at these things as the scarlet letter of corporate finance," he added.
Other bankers take a less severe view, but most agree that the use of PIKs or discount bonds raises a red flag.
"It clearly calls your attention to the [capital] structure" of the, deal, said Mr. Bunn at NationsBank.
Not Quite Like '80s
Despite the increased use of these securities in recent months, bankers and others are quick to point out that while more aggressive than just six months ago, the deal market today is a far cry from the 1980s.
"I still haven't seen it get to the point where somebody shows up with a dollar and a half and a good story and can borrow a bunch of money in the high-yield market, and banks will accept that." said Mr. Muse.
The overall credit quality and structure [of deals) is much stronger than it was in the 1980s," said Ted Virtue, managing director in charge of high-yield capital markets and loan syndications at Bankers Trust New York Corp.
Sense of Caution
But bankers are also on guard against their own impulses.
"If we go back to allowing very aggressive leverage on the balance sheet and hockey-stick projections, it's going to be the 1980s all over again," NationsBank's Mr. Bunn said.
Added Continental Bank's Dennis Amato: "My sense is that it hasn't reached crisis proportions, but if the trend line continues in terms of aggressiveness, we'll probably repeat some of the problems of the late 1980s."
