The LBO Market is in ‘disarray’ after Harrah’s upset.

The leveraged loan market begins the week in “disarray” following the collapse of efforts to syndicate $14bn of the debt used to finance the $30bn buy-out of Harrah’s Entertainment, bankers say.

The group of banks backing buyers Apollo Management and Texas Pacific Group are having trouble selling on the leveraged buy-out debt to third parties. With the bulk of the debt remaining on their books, the banks are sitting on a sizeable loss.

The freeze in the debt market means they now face larger potential losses on other big buy-outs, such as BCE and Clear Channel Communications, and will be more desperate to get out of the financing commitments on those deals.

Banks are already saddled with more than $150bn of unsyndicated debt, most of it LBO-related, according to S&P; data. Virtually every loan-backed buy-out deal done in the past few months is trading well below 90 cents on the dollar.

My Comment: Underwriting fees was a big source of profits last year. Now banks are stuck holding the bag on deals nobody wants. Think this is just a blip in profits? Think again.

Credit Suisse, under pressure to get its lending exposures down, sold about $1bn of its share of the debt ahead of the agreed schedule, infuriating the other banks. Credit Suisse informed fellow members of the syndicate of its intention in early January, according to one person familiar with the matter.

“There is no contractual obligation,” this person added. “We cannot concede control over our own capital.” That may be the pattern in future deals. “The Harrah’s precedent frees other underwriters to deal with situations as they see fit,” noted Standard & Poor’s Weekly Wrap.

My Comment: This looks like a case of “New Rules”. Credit Suisse did not want to go down with the ship. Who’s next?

“The market is in total disarray,” said the head of debt capital markets at one major Wall Street firm. Another senior banker involved in the deal added: “The last 10 days have been the worst ever. There is a complete buyers’ strike.”

My Comment: There’s not a buyer’s strike. There’s a seller’s strike. There are plenty of buyers, just not at the expected prices. It’s the same story in the housing market. Everyone wants the price they could have gotten 6 months ago. That price is no longer available. Seller’s need to be more reasonable about expectations.

Ironically, the Federal Reserve’s dramatic 1.25 percentage point cut in interest rates in January contributed to Harrah’s problem, because loans are floating rate and with benchmarks such as Libor dropping, returns to investors fall proportionately.

The Fed rate reduction also meant lower returns on earlier deals to finance the mega buy-outs of the last few months, including the loans on deals such as First Data and Alltel.

The head of debt at one private equity firm said: “Technical factors haven’t been fixed and the bad macro outlook has kicked in.

My Comment: One has to laugh at the irony of this. The Fed, by attempting to bail out homeowners, has instead hurt the commercial real estate deals. The residential market is long past saving.

“Even if you are comfortable with the individual credit, why bid when the market is going lower?”

Why bid when the market is going lower?

That last sentence says it all. Attitudes have changed. Attitudes are critical. See Changing Social Attitudes About Debt and The Business of Walking Away for more about attitudes.

It was changing attitudes that sunk home prices. Now attitudes are impacting LBOs in a major way. This is just the beginning of the unwinding of attitudes towards both consumption and risk.

A Crash Course For Bernanke about attitudes is now in progress.

Mike “Mish” Shedlock
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