NEW YORK – The cost to finance leveraged buyouts in the U.S. is the highest since December as Europe’s debt crisis and a weakening economy damps demand for high-yield, high-risk loans.
Average monthly interest rates on institutional leveraged-loans, or the debt used to finance LBOs, rose to 491 basis points more than benchmarks in July, according to Standard & Poor’s Leveraged Commentary & Data. Margins increased from a February low of 378 basis points. The difference equals an extra $11.3 million in annual interest for every $1 billion borrowed.
Rhode Island's Market Has Changed. Developers, Builders, Investors and Sellers Must Change With It.
By Emilio DiSpirito IV License Partner | Engel & Völkers Oceanside Leader | The DiSpirito…
Learn More
Banks have committed almost $14 billion of financing, including $10.3 billion of loans for buyouts such as Apax Partners LLP’s $6.3 billion LBO of Kinetic Concepts Inc., according to Barclays Capital. Investors pulled $1.36 billion from floating-rate funds that buy loans in the week ended Aug. 10, a day after the Federal Reserve pledged to keep its benchmark rate at a record lows until at least mid-2013 as the economic recovery falters.
Buyout firms “are going to have to pay up for the capital,” said Jonathan Insull, a money manager in New York at Crescent Capital Group, which oversees about $10 billion of speculative-grade debt. “They need the money. It’s not an opportunistic financing.”
More Bonds
Apax plans to fund its buyout of Kinetic, the biggest LBO since the collapse of Lehman Brothers Holdings Inc. in September 2008, with $4.95 billion of loans and bonds. The financing mix, which includes $2.15 billion of notes and a $2.6 billion term loan, is more skewed toward bonds than the second-largest LBO of the year, KKR & Co.’s $5.3 billion buyout of Del Monte Foods Co., which closed in March.
“As the market stabilizes, we will likely continue to see increasing weight given to bonds in LBO capital structures,” said Brendan Connolly, global head of leveraged finance at UBS AG in New York.
Elsewhere in credit markets, the cost of protecting company bonds from default in the U.S. declined for a second day and JPMorgan Chase & Co. lowered its forecast for returns on high- yield debt.
The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 3.5 basis points to a mid-price of 111.8 basis points as of 11:22 a.m. in New York.
Credit swaps pay the buyer face value if a borrower fails to meets its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Reduced Returns Forecast
JPMorgan reduced its returns forecast for high-yield bonds and leveraged loans amid concern that central banks will be unable to staunch a spreading global sovereign-debt crisis.
Junk notes may return 6.6 percent for the year compared with a prior estimate of 9 percent, analysts led by Peter Acciavatti in New York wrote in a report dated Aug. 12. Loans may gain 1 percent for 2011 versus a previous prediction of as much as 6 percent.
“Risks to the global economy are extensive,” according to the analysts from JPMorgan, the leading underwriter of high- yield bonds in the U.S. While default rates remain low, “we also recognize the risk of wider spreads in the near-term due to significant uncertainties.”
Loan prices fell 4.4 percent last week to 88.36 cents on the dollar, according to the S&P/LSTA U.S. Leveraged Loan 100 Index. They dropped to 88.2 on Aug. 11, which was the lowest since July 13, 2010. Losses for the year on the corporate debt, rated less than Baa3 by Moody’s Investors Service and lower than BBB- by S&P, deepened to 4.07 percent.
‘Sell-Off Overdone’
“The sell-off looks overdone in the loan market,” Insull said. “Guys are trying to get more selling done in anticipation of outflows.”
Floating-rate funds, which invest in bank loans, had record outflows of $1.36 billion during the week ended Aug. 10, according to EPFR Global. The previous record was $1.33 billion in the week ended August 1, 2007. EPFR began tracking the fund group in the first quarter of that year, said Cameron Brandt, a director of research for the Cambridge, Massachusetts-based firm.
Demand for the debt has declined after U.S. economic growth almost stalled in the second quarter and Congress established a “super-committee” to come up with at least $1.2 trillion of deficit reductions beyond the more than $900 billion lawmakers agreed to after haggling over a plan on how to raise the U.S. debt ceiling. S&P stripped the nation of its AAA credit rating on Aug. 5 because the initial spending cuts didn’t go far enough. Fitch Ratings and Moody’s affirmed their top grades for the world’s biggest economy.
‘Dampening Effect’
French President Nicolas Sarkozy and German Chancellor Angela Merkel will meet in Paris on Aug. 16 to discuss keeping Europe’s sovereign-debt crisis from spreading after French markets were roiled. Greece, which in June passed an austerity plan needed for a second European bailout, is seeking further savings to meeting its 2011 deficit target.
“Austerity, as it’s kind of laid out, will have a dampening effect on global economies,” Bill Sonneborn, the chief executive officer for KKR Financial Holdings LLC, said on an Aug. 1 earnings call with investors and analysts. “We expect interest rates to stay relatively low for at least the next 18 to 24 months through the election cycle.”
KKR Financial, based in San Francisco, is the publicly traded credit business of KKR & Co., the buyout firm managed by Henry Kravis and George Roberts.
Del Monte Financing
Del Monte’s LBO was funded with $1.3 billion of 7.625 percent notes and a $2.7 billion term loan that pays lenders 3 percentage points more than benchmarks, according to data compiled by Bloomberg. The company also received a $750 million revolver.
Companies issued $24.4 billion of leveraged loans last month, the fewest since December, when $21 billion of new loans were raised, according to S&P’s LCD. The peak was in February, when banks underwrote $69.5 billion of the floating-rate debt.
High-yield bond issuance totaled $18 billion in July, down from this year’s monthly high of $44.3 billion in May, according to Bloomberg data.
“LBO firms would like to get as much first-lien bank debt as they can,” said Craig Packer, the New York-based head of Americas leveraged finance for Goldman Sachs Group Inc. “Leveraged loans are less expensive and pre-payable.”
Financing Flexibility
Blackstone Group LP plans to back its $3 billion purchase of healthcare billing company Emdeon Inc. with a $1.2 billion term loan and as much as $750 million of notes, according to a regulatory filing. Bank of America Corp., Barclays Plc and Citigroup Inc. have agreed to provide a $750 million bridge loan to cover the balance not sold in the note offering. The lenders are also providing Emdeon with a $125 million revolver.
“Underwriters want to be able to tap both markets and give themselves the flexibility of tapping the bond market to a greater extent,” said Packer.
TPG Capital is funding its $1.97 billion buyout of Immucor Inc., a maker of tests used to screen blood before transfusions, with a $600 million covenant-lite term loan that has less protections for lenders than traditional bank debt and $400 million of senior unsecured notes.
“You always like to see a junior debt cushion if you are a senior secured loan investor,” Insull said.
‘Market Capacity’
Buyout financings are now being structured to allow for a greater portion of bonds, especially in the larger deals, though loans will likely remain the larger piece, said Packer. Bonds typically made up about a third of the debt backing large LBOs before the financial crisis, with loans comprising the remaining two-thirds of the capital structure, he said.
“With current market volatility, as bond market investor demand ultimately outstrips that in the loan market, underwriters and issuers will focus on the market capacity and price elasticity of the bond market,” Connolly at UBS said.
The buying power of collateralized loan obligations, which invest in bank loans, is shrinking as CLOs exit their re- investment periods and new ones aren’t being raised fast enough to replace them, Insull said.
Private-equity firms buying Blackboard Inc. and BJ’s Wholesale Club Inc. are seeking to back their deals entirely with bank debt.
Providence Equity Partners Inc. is financing its $1.64 billion purchase of Blackboard, an education-software maker, with $1.15 billion in loans including a revolver, according to a regulatory filing. Leonard Green & Partners LP and CVC Capital Partners plan to back their $2.8 billion purchase of BJ’s with $2.575 billion of debt, including $1.675 billion of first and second-lien term loans and a $900 million first-lien asset-based loan.
JPMorgan high-yield strategists said in an Aug. 12 report that they see loan spreads reaching 740 basis points by year- end.
“Spreads are elevated and they will remain elevated and probably go wider,” said Crescent’s Insull.
