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The Problem With Private Equity Buying Leveraged Loans

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by Felix Salmon
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Apr 14 2008 12:00am EDT

The Problem With Private Equity Buying Leveraged Loans

Remember how those private-equity companies are buying back a bunch of their own debt at 90 cents on the dollar? Well, if it's literally their own debt, rather than simply a bunch of leveraged loans in general, then Equity Private notes there might be a problem:

The equity holders in these companies that have taken the loans have to be 'at risk' with respect to the debt holders, and the debt holders have to act like debt holders and demand regular payments and enforce defaults or the IRS will characterize the capital as an equity investment and bounce the deductions on the debt payments that these companies have been filing.

In other words, there's a reason why shareholders and bondholders are generally two different sets of people: the IRS frowns on companies making interest payments to themselves and then taking a tax deduction for doing so. Still, I'm sure that Leon Black et al are smart enough to work out how to get around this without being accused of forming a you-scratch-my-back-I'll-scratch-yours cartel.

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