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KKR Deal Offers Lessons in Risky Lending

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August 7, 2015

 

Private equity investments always come with a risk, but some deals, and indeed industries, are far more risky than others. KKR’s last year investment in an energy sector company, Preferred Sands, started out as a win-win deal, but it has now turned sour for the private equity firm.

 

The Deal

 

Last year, KKR bought Preferred Sands in a deal worth $700 million. The deal helped the energy company avoid bankruptcy, while KKR managed to snatch the company ahead of competition.

 

KKR also partnered with Jefferies Group as part of the deal. This partnership agreed to syndicate the six-year term loan. Furthermore, the private equity firm gave a $300 million loan and a $50 million asset-based credit line. This provided the firm a 40% stake in the company.

 

Things Turn Sour

 

But the energy industry has seen its fortunes go down, as global crude oil prices has continued to sink. While cost of crude stood at $100 last year, the price has almost halved and the price of the loan has rapidly declined.

 

The $350 million, first-lien loan has dropped below 75 cents on the dollar, according to Bloomberg. The deal has turned from a win-win deal to evidence that cyclical businesses have a higher risk in the sector.

 

Preferred Sands had problems attracting loans before the KKR deal exactly because banking regulators didn’t feel comfortable with the risk. A year later, it’s easy to say the banks’ cautious approach was probably justified.

 

Trying to Change Fortunes

 

Preferred Sands had a debt problem and it struggled throughout the height of the energy boom because of this. KKR took a bet against the massive debt and hoped a restructuring plan could help bring more fortunes for the firm.

 

Matt Goldstein, Preferred Sands’ spokesperson from the communication firm Brian, told Bloomberg in an e-mail, the drop in loan prices is more down to general market conditions in the industry rather than bad performance by the company. “The drop in the loan was a result of our competitors’ recent public announcements and the overall market, and therefore is not directly related to the company’s performance,” he wrote.

 

The Lessons in Risky Lending

 

Regulators are increasingly wary of risky lending and many businesses across the globe are finding it tough to attract capital. Private equity has stepped in and helped many companies back on their feet, but in some situations, deals have gone sour.

 

To Karen Shaw Petrou, managing partner at Federal Financial Analytic, the question is now “the extent to which this is occurring and whether or not that creates systemic market risk.” “Are the enough of these loans out there that could lead to defaults across the sector?” she asked in a Bloomberg interview.

 

Some industry analysts are painting an increasingly dark picture of risky lending. In a Bloomberg TV interview, John Thain, the CEO of CIT Group, said, “if you wanted to worry about the next crisis, you would about that space (risky lending) because that’s where the more leveraged, the more risky pieces are going”.

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