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Leveraged Buyouts: Risk Considerations for Exceeding Leverage Limitations

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In the aftermath of the 2008 financial crisis, banking regulators have been taking a more active role in pursing greater financial stability. One area of focus has been on Wall Street banks' leverage lending practices which include leveraged lending activities to fund leveraged buyouts. In March 2013, the Federal Reserve…

In the aftermath of the 2008 financial crisis, banking regulators have been taking a more active role in pursing greater financial stability. One area of focus has been on Wall Street banks' leverage lending practices which include leveraged lending activities to fund leveraged buyouts. In March 2013, the Federal Reserve and the Office of the Comptroller of the Currency issued guidance urging banks to avoid financing leveraged buyouts in most industries that would put total debt on a company of more than six times its earnings before interest, taxes, depreciation and amortization, or Ebitda. Our research, using data on all leveraged buyouts (with EBITDA >$20 million) issued after the guidance, sets out to explain the elements banks consider when exceeding leverage limitations. Initially, we hypothesized that since deals over 6x leverage had higher amounts of debt, they were riskier deals, which would carry over to other risk measures such as yield to maturity on debt and company credit ratings. To analyze this, we obtained a large data set with all LBO deals in the past three years and ran difference-in-means tests on a number of variables such as deal size, credit rating and yield to maturity to determine if deals over 6x leverage had significantly different risk characteristics than deals under 6x leverage. Contrary to our hypothesis, we found that deals over 6x leverage had significantly less risk, mainly demonstrated by lower average YTMs, than deals under 6x. One possible explanation of this might be that banks, wanting to ensure they are not fined, will only go through with a deal over 6x leverage if other risk metrics such as yield to maturity are well below average.
ContributorsKing, Adam (Co-author) / Lukemire, Sean (Co-author) / McAleer, Stephen (Co-author) / Simonson, Mark (Thesis director) / Bonadurer, Werner (Committee member) / Department of Finance (Contributor) / Department of Economics (Contributor) / Barrett, The Honors College (Contributor)
Created2016-05