Warner Chilcott Deal Could Reopen Leveraged-Loan Market

By MICHAEL ANEIRO Warner Chilcott PLC's $4 billion loan to fund the purchase of Procter & Gamble Co.'s prescription-drug business could be the wake-up call the leveraged-loan market has been waiting for. The market for risky loans, the predominant financing vehicle for leveraged buyouts during the boom years, has been dormant since the credit crunch erupted in late 2007. That is even as other risky asset classes, including the junk-bond market, have staged a comeback as the financial crisis eased. Early this year, higher-rated, familiar companies in favored industries were the first to re-enter the high-yield bond market after it had seized up during 2008, and scores of other issuers have now followed. The Warner Chilcott deal could serve a similar function for the leveraged-loan market: It comes with relatively high double-B ratings, low leverage, strong cash flow and strategic rationale that should lure hesitant loan investors. "These are the kind of little steps the market has to take to move forward," said Russell Morrison, managing director for bank loans at Babson Capital Management. The Warner Chilcott deal for Procter & Gamble's prescription-drug unit may revive the dormant leveraged-loan market. Above, the headquarters complex of Procter & Gamble in Cincinnati, Ohio The transaction poses a test for the banks, which want to show that their loan-underwriting desks are again open for business but remain loath to hold large loan commitments on their own books. Banks typically syndicate loans to investors, but the credit crisis has hurt the normal investor base. Banks are willing to underwrite deals, said one member of a Wall Street loan-syndication desk, but want to know they can sell loans on to investors. Banks will start that process for Warner Chilcott after the Labor Day holiday. Loans are senior to bonds and secured by assets. Companies like loans because they pay lower interest rates than bonds and can be repaid early. Amid last year's credit crisis, however, new loan issuance stalled, while prices on existing loans tanked. At the same time, collateralized loan obligations, or CLOs -- leveraged, structured investment vehicles that at one time owned more than half of bank loans -- had to delever, and demand for loans dried up. New bank credit-facility issuance has plunged to a projected $48 billion in 2009, according to Moody's Investors Service, a fraction of the $596 billion in 2007. Without access to new loan financing, borrowers with maturing bank debt have been enticing investors to extend the maturities of existing loans or have issued high-yield notes to repay loans. In 2009 so far, $50 billion of institutional loans have been repaid, with half of that amount coming from bond-for-loan takeouts, according to J.P. Morgan Chase. CLO managers have used money from repaid loans to buy new ones, and cash has flowed into the market from other types of funds, such as high-yield and prime-rate mutual funds in search of higher returns. Loan prices have recovered to 90 cents on the dollar from just 67 cents at the end of 2008, according to Standard & Poor's Leveraged Commentary & Data. New CLO issuance remains essentially nonexistent, however, raising the question of where demand for new loans will come from. Currently, the market is exploring new sources of liquidity that may include CLOs, perhaps in a modified form, said Bram Smith, director of the Loan Syndications and Trading Association. Mr. Smith and others say the real key to a rebound is a resurgence in merger-and-acquisition activity, historically the major driver behind loan issuance. If M&A ticks up, companies drawn to bank loans will find ways to make them palatable to investors, as they will try to do in the Warner Chilcott deal. "It's hopefully the start of the slow trend to allow loans to become part of companies' capital structures again," Babson's Mr. Morrison said.