Private equity houses snap up cheap debt

Concerns are mounting over private equity investors or the companies they own buying back debt at a discount from banks and undermining the principles of syndicated lending. Banks are alarmed at the prospect of companies picking off members of a lending syndicate to purchase their own debt when syndicates are meant to stick together.

The Bank of England is also thought to be concerned about banks selling off debt at big discounts to clear up their balance sheets. As well as throwing the loans market into confusion, the practice triggers writedowns that could prolong the lack of confidence in the financial system.

The credit crunch has left banks saddled with many billions of dollars of debt. To free up funds for new lending and to demonstrate strong balance sheets, lenders have started selling debt back to borrowers. TDC, the Danish telecoms operator bought for €13bn (£10.2bn) by private equity investors in 2005, has bought back €200m ($101m) of loans at a discount, unnerving banks which were not approached. Citadel Broadcasting, the US radio operator, approached its lenders in March about buying back $200m of its debt for about 80 cents in the dollar.

Private equity companies are awash with cash they cannot put to work because banks are not providing the leveraged loans needed for takeovers. Buy-out houses are now looking to buy back debt in companies they own at massive discounts to hold the loans to maturity, armed with detailed knowledge of the company's prospects.

Neil Murray, a banking partner at the law firm Travers Smith, said clients had bombarded him with inquiries about the practicalities and legal implications of such buy-backs. "It is bad news for banks because it seems to drive a coach and horses through the principles of syndicated lending," he added. "For the Bank of England, if the discounts are considerable, that can lead to more writedowns by banks."

Legal complications can arise if a private equity company buys the debt because it is then classed as a lender to the company, potentially giving it voting rights in a restructuring even though it owns the business.

The Loan Markets Association, set up by City law firms to standardise debt documentation, is expected to announce changes to its guidelines as early as this week. But the shake-up will do little to prevent conflict over deals which are already agreed, unless new conditions are written in to contracts in the current round of restructurings. "These are done deals. We've learnt a lesson from the credit crunch," Mr Murray said.