Tuesday, February 19, 2008
Low Rates Make Buyout Debt a Burden
--Lower interest rates may be a way to jump-start the broader economy, but right now they are serving only to further stall movement of the massive backlog of leveraged-buyout debt sitting on banks' books. --As the Federal Reserve slashes interest rates and pumps massive amounts of liquidity into strained short-term money markets, the benchmark rate off which loans are priced -- the London interbank offered rate -- has fallen sharply, from above 5% late last year to just above 3% last week. --That has forced banks to restructure new loan deals by offering investors a "Libor floor" -- a guarantee that if Libor drops any further, investors will still get a certain yield. That guarantee doesn't exist for old LBO debt. On top of that, the investor base for loans has changed -- from alternative investors immune to Libor risk to long-term investors who are more focused on real returns and hence sensitive to the ever-shrinking yields caused by Libor's decline. --For old LBO loans -- of which some $150 billion is sitting on bank balance sheets waiting to be sold -- falling Libor just adds another negative. Banks are committed to financing LBOs with debt that doesn't include Libor floors. They could go back to the private-equity firms to negotiate the addition of such floors, but there are no guarantees the firms will agree. --The backlog of LBO financing is uglier still because it is being issued by companies that already carry hefty debt loads. It also is debt that was negotiated with low risk premiums and weak covenants, or protective provisions for investors, that reflect a far more bullish time in the risky debt markets than is the case today. --"New debt is going to be structured more to today's reality. It will have wider spreads, it's much more likely to have Libor floors, more stringent prepayment provisions," said Steve Miller, managing director of Standard & Poor's Leveraged Commentary & Data unit. --On old LBO loans, banks may well just have to bite the bullet. "The only thing you can do with those," said Mr. Monteith, "is bring them at a steeper and steeper discount."