Wall Street Blocked By Buy­out Debt

Banks Find Few Tak­ers for Loans Fund­ing Deals

The Washington Post - - Business - By David Cho

Wall Street banks have failed to un­load $220 bil­lion of debt, which fi­nanced a wide range of ma­jor cor­po­rate buy­outs ini­ti­ated over the past two years, and that back­log is chok­ing the credit mar­kets de­spite re­cent ef­forts by the Fed­eral Re­serve and Trea­sury to in­vig­o­rate the econ­omy.

The trou­bles have en­snared such ma­jor ac­qui­si­tions as Har­rah’s Casino Ho­tels, All­tel and Chrysler. Some deals could un­ravel if banks can­not find back­ers for the buy­out loans they com­mit­ted to fund­ing. This could fur­ther shake in­vestors’ con­fi­dence in a fi­nan­cial sys­tem reel­ing from mas­sive losses in home mort­gages.

The in­sti­tu­tional loan mar­ket, where buy­out loans are priced and traded just like stocks on an ex­change, has re­mained frozen far longer than top private-eq­uity in­vestors pre­dicted. Last sum­mer, some of th­ese in­vestors said it would take about six months for the credit mar­kets to clear the log­jam of buy­out debt.

In­stead, loans for deals as old as Clear Chan­nel Com­mu­ni­ca­tions, which was swung in 2006 for $18.7 bil­lion, are still get­ting the cold shoul­der from debt in­vestors.

“Six months ago, we were say­ing it’s go­ing to take six months to work through this debt,” said Christo­pher Donnelly, vice pres­i­dent of Stan­dard & Poor’s Lever­aged Com­men­tary & Data. “Well, what hap­pened was none of this pa­per was sold . . . and now we think it’s go­ing to take much longer to clean this up.”

Debt in­vestors, which in­clude hedge funds, spe­cial­ized in­vest­ment firms and big bro­ker­ages, have for years been ma­jor buy­ers of loans from Wall Street banks, free­ing banks to lend even more money. This is a key rea­son lend­ing surged

in the past five years, lead­ing to a boom in mort­gages, car loans, credit cards and big private-eq­uity deals.

But af­ter ab­sorb­ing mas­sive losses from their port­fo­lios of subprime mort­gages, the in­vestors have be­come un­will­ing or un­able to buy loans of any kind.

“Peo­ple woke up af­ter they got spooked by subprime,” said Colin Blay­don, di­rec­tor of the Cen­ter for Private Eq­uity and En­trepreneur­ship. “The mort­gage mar­kets got souped. That’s why in­vestors ran away from them, and many of th­ese in­vestors were the same ones who were hold­ing lever­aged loans.”

Banks, in­clud­ing nearly all of the big­gest names on Wall Street, are be­ing forced to hold onto that debt. This has a chill­ing ef­fect on their op­er­a­tions and hurts earn­ings, sim­i­lar to the way large in­ven­to­ries of un­sold clothes dampen prof­its at re­tail stores. A ma­jor source of in­come for banks is the fees they gen­er­ate from mak­ing loans, repack­ag­ing them as se­cu­ri­ties and sell­ing them to debt in­vestors.

Now they face a dif­fi­cult choice. They can ei­ther sell th­ese loans at ex­treme dis­counts and take the losses or hold onto them and hope the ap­petite for buy­out debt re­vives.

As of this week, the banks were strug­gling to sell $152 bil­lion in buy­out loans and $68 bil­lion of buy­out bonds, ac­cord­ing to Donnelly. With such a mas­sive amount in the pipe­line, th­ese fi­nan­cial firms have lit­tle money or de­sire to back new buy­outs.

“You won’t see any more gi­gan­tic deals for a while,” Donnelly added.

The stock mar­kets could also suf­fer be­cause private-eq­uity deals al­most al­ways boost the share prices of com­pa­nies that are be­ing ac­quired. What’s more, af­ter own­ing a firm for sev­eral years, a buy­out firm of­ten re­coups its in­vest­ment by putting the com­pany back on the pub­lic stock mar­kets. Last year, private eq­uity was re­spon­si­ble for 44 per­cent of all ini­tial pub­lic of­fer­ings, ac­cord­ing to data col­lected by Dealogic, an in­de­pen­dent re­search firm. In gen­eral the stocks in those of­fer­ings did much bet­ter than other IPOs, the re­searcher said.

The credit crunch has al­ready scut­tled ma­jor deals and called oth­ers into ques­tion. This week, the $6.8 bil­lion takeover of Al­liance Data Sys­tems col­lapsed af­ter its buyer, private-eq­uity gi­ant Black­stone Group, told the firm it was back­ing out. The banks un­der­writ­ing that deal have been un­able to find back­ing for $3 bil­lion worth of fi­nanc­ing. ADS sued Black­stone yes­ter­day in an at­tempt to force it to com­plete the ac­qui­si­tion.

Two of the first failed deals in­volved Wash­ing­ton area firms. The $8 bil­lion buy­out of elec­tron­ics maker Har­man In­ter­na­tional un­rav­eled days be­fore the $25.3 bil­lion ac­qui­si­tion of stu­dent lender Sal­lie Mae. More than a dozen oth­ers ran into trou­ble as pri­va­tee­quity firms en­dured bouts of buy­ers’ re­morse.

The shares of sev­eral firms that had agreed to takeovers have dropped sig­nif­i­cantly be­low their ac­qui­si­tion price, a sign that in­vestors are skep­ti­cal that the buy­outs will go through. Thomas H. Lee Part­ners and Bain Cap­i­tal Part­ners had agreed to pay $37.60 a share for Clear Chan­nel in 2006, for in­stance. But yes­ter­day the stock closed at $29.04, more than 22 per­cent lower than the buy­out price.

Trea­sury of­fi­cials have pro­posed sev­eral mea­sures to shore up con­fi­dence in the credit mar­kets, in­clud­ing a mort­gage re­lief plan that may lead to more mort­gage lend­ing. The Fed also has been cut­ting rates ag­gres­sively, re­duc­ing a key short-term lend­ing rate yes­ter­day by 50 ba­sis points barely a week af­ter an even steeper cut.

U.S. Trea­sury As­sis­tant Sec­re­tary An­thony Ryan said this week there are signs th­ese moves are start­ing to work. As ev­i­dence, he pointed to the as­set-backed com­mer­cial pa­per mar­ket, which is be­gin­ning to stir af­ter be­ing shut down for months.

He added that it may take time for other seg­ments of the credit mar­kets to re­turn to nor­mal.

“This is cer­tainly not an ‘all­clear’ sig­nal, but per­haps the be­gin­ning of the tran­si­tion to an im­proved state,” Ryan said at a fi­nan­cial con­fer­ence in New York. “This process will take more time.”


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