Private equity boss Jon Moulton, who quit Alchemy Partners amid some controversy last month, has provided a unique insight into what went wrong with the banks from about 2005 onwards.
Moulton said: “I was a critic of the immense levels of debt people were using too early. I first had a go at the debt market at a British Bankers’ Guild event in September 2005 and I made a PowerPoint presentation that had a picture of a falling-down wedding cake as the image on every page.
“I knew we had a problem because no one disagreed with me — and that was a room full of bankers. They were all making so much money, and enjoying themselves so much, that they were happy to go along with it. They didn’t care if there was a big bust.
“At the end of that conference my cynicism was reinforced. Two blokes came up from major banks and they were both from credit, and they said: “We don’t do a job in credit any more, all we do now is see if we can distribute.”
In an interview with trade magazine EVCJ, Moulton continued: “The market had already moved. Fundamentally, the bankers involved didn’t care whether they were good deals or not because they weren’t going to be sitting on the assets. So we had this loss of integrity after that.
“We saw a rapid and increasing arrival of pro-forma EBITDAs, adjusted EBITDA (earnings before interest, tax, depreciation and amortization), and almost the elimination of due diligence.”
In an earlier viewpoint article published in Bloomsbury Publishing’s Qfinance this month, Moulton wrote: “The large buy-outs which took place in the bubble years of 2005 to mid 2007 now look like horrible aberrations. In fact, they were horrible aberrations.
“Many of these deals were priced at such levels that real profits now need to grow by 50% or more for the equity to achieve the same value buyers paid when the deal was closed. This is a big ask in normal conditions, and is much, much harder in a recession
“Then, of course, there are the balance sheets of most of these deals, where debt levels are high by any historic measure. Debt at eight to ten times EBITDA is far from unusual — and much of this debt is now trading below 65p to the £1. Refinancing at current levels seems impossible in the tortured debt markets now prevalent, where even three times EBITDA is often impossible to fund.
“Many of these large deals will run into financing problems over the next few years, indeed some are already doing so ….
“One uncomfortable truth that is being recognized, at a pace reflecting the pain of this recognition, is that buying a company with 40% equity and 60% debt in mid-2007 meant that by the end of 2008, even if profits remained stable, the equity had no real value.”
From waht Jon says, it sounds like the chickens will be coming home to roost from the bankers’ and the private equity boys’ years of crazed excess for some time to come.
As is clear from the case of HBOS, if money is being lent and investments being made without proper due diligence, it doesn’t only means that rubbish deals get done (i.e. that eye-watering prices/multiples are paid for overpriced assets). It also leaves the door wide open to corruption and fraud.
This blog post was published on 12 October 2009
As a former (reformed?) leveraged finance analyst, I can attest to the truth of this. Indeed, my former employers recently came to own one of the businesses we lent to – we couldn’t syndicate the loan after the crisis broke. The deal was structured at something like 7.5x adjusted EBITDA, which was essentially a made up number taking into account projected cost savings and earnings from planned acquisitions discounted back, etc.
chickens coming home to roost indeed, but only in terms of loans that the banks had to sit on. All the deals we did were not driven by credit concerns as much as syndication concerns. If we didn’t do the deal, with the PE shops dictating eye-gouging terms, some other bank would. Not trying to justify any of it, but the whole world was mad then. It was contagious.