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A Recovery For LBO Debt?

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Are buyers for LBO debt back? Monday's $11.5 billion debt offering for Energy Future Holdings, the company that is taking over for TXU, reportedly went much better than many expected. The underwriters—Citigroup , J.P. Morgan Chase, Goldman Sachs, Morgan Stanley, Credit Suisse and Lehman Brothers—are said to be offering the loans almost at par and the $11.5 billion is about twice what they originally planned to offer in the first round. S&P says the debt will be sold at 99.5 cents on the dollar, much higher than many loans have recently priced and much higher than the underwriting group expected less than a week ago.
Apparently, buyers have in fact been won over by the “toothless” maintenance covenant the KKR agreed to add to the debt.
The debt is just a small portion of the total debt for the TXU deal, and banks are still struggling to place LBO debt they have sitting on their books. Where they have succeeded in selling the debt, they’ve often had to offer the loans at discounts that price the loans at 97 cents to 95 cents on the dollar.
Last week Goldman sold a $100 million piece of the $2 billion term loan used to finance KKR’s acquisition of US Food Service, according to the Deal’s David Carey. Those loans had been sitting around since the deal closed in early July. We haven’t been able to get a hold of the pricing on that one, however.
Other recent loan placements have come with higher discounts, but not as high as many anticipated. Loans for the acquisition of First Data priced at between 96 cents and 98 cents on the dollar. Loans for the private equity buyout of Allison Transmission sold for 96 cents. That still stings for the banks but doesn’t quite create the potential upside that many so-called “vulture funds” were hoping for.
Indeed, Mike Flaherty has a story in Reuters indicating that this unexpectedly swift recovery in the loan market has some “questioning the wisdom” of LBO debt funds reportedly in the works from Citi, Goldman, KKR and TPG. The idea behind some of these funds is typical financial hucksterism: if you lose a dollar going in, make sure you make two bucks on the way out. So if you’re a bank selling LBO loans at a discount, might as well buy some up and try to participate on the upside of the discounting. But if you’re placing the loans at close to par, maybe you don’t need to a vulture fund to capture the potential upside.
But, then again, Bernanke, Paulson and the Beige Book have all been making dire sounds about the economy. (Yeah. Yeah. Books don’t make “sounds.” Whatever.) And if the economy slows and the prospects for the portfolio companies seem darker, this early recovery for the credit markets may seem like wishful thinking. And, of course, this may open up opportunities for the vulture funds.
Of course, even the vulture funds rest on rosy assumptions about the economy and the prospects of borrowers. If things get real bad, vulture funds started as pseudo-hedges against losses in syndication may end up multiplying losses through the use of leverage to buy the loans.
TXU debt not such a hard sell [The Deal]
Banks work through loan overhang [Dealscape]
New debt funds get off to a tough start [Reuters]