Hot money abandons credit markets, Loans find few buyers

LBO `Freeze' Shuts Wall Street Pipeline; $1.3 Billion Dries Up
By Edward Evans and Jason Kelly

Aug. 6 (Bloomberg) -- While investment bankers feasted on an unprecedented $8.4 billion of fees for arranging leveraged buyouts in the first half, the rest of the year may prove to be a famine.

``It's impossible to conclude that it's not going to be a tougher time for Wall Street,'' said Steven Rattner, co-founder of New York-based buyout firm Quadrangle Group and former vice chairman of Lazard Freres & Co. ``There's going to be an impact on revenues and profits.''
While no one's predicting a Biblical seven-year drought, the pace of buyouts has slowed more than 33 percent since June, data compiled by Bloomberg show. Investors are cutting back on riskier assets such as the loans and bonds that fund LBOs after being burned by losses from U.S. subprime mortgages. At that rate, banks would miss out on at least $1.3 billion of fees in the second half.

JPMorgan Chase & Co., the third-biggest U.S. bank, has the most at stake after earning more than anyone else from arranging leveraged loans in the first half. Together with Credit Suisse Group and Deutsche Bank AG, it made a combined $919 million from loans in period, data compiled by New York-based Freeman & Co. and Thomson Financial show. The three also got $426 million for advising LBO firms on takeovers and $190 million from bond sales.

Mortgage defaults by Americans with poor credit histories prompted the collapse in June of two hedge funds managed by Bear Stearns Cos. and triggered a worldwide rout in the debt markets. Companies such as London-based Cadbury Schweppes Plc, the world's biggest candy maker, have delayed asset sales, and banks including New York-based JPMorgan and Frankfurt-based Deutsche Bank have been left on the hook for as much as $300 billion of debt they've agreed to provide for LBOs.

`Grinding Halt'
``There's indigestion, as investors aren't buying the paper to the extent that they were buying it before, and banks will be nervous about committing to any new significant underwritings of any size,'' said Daniel Stillit, a London-based analyst at UBS AG. ``There's a significant risk of the LBO driver coming to a grinding halt.''

A 50 percent drop in income from arranging buyouts and other ``higher-risk credit,'' together with a 10 percent decline in other investment-banking revenue would slash earnings at Zurich- based Credit Suisse by 19 percent, London-based Deutsche Bank analyst Matt Spick said in a July 26 note to investors. Credit Suisse spokeswoman Rebecca O'Neill declined to comment.

Private-equity firms announced a record $616 billion of buyouts in the first half, capping four lucrative years of deals, according to Bloomberg data. New York-based Morgan Stanley, the second-biggest U.S. securities firm, is set to earn $45 million from New York-based Kohlberg Kravis Roberts & Co. for the $25.6 billion buyout of First Data Corp., the world's largest processor of credit-card payments.

Chrysler Sale
The takeovers have depended on the banks finding investors to buy debt. LBO firms use borrowed money to fund about two thirds of the cost of the deals. Bankers typically earn fees of 2 percent for underwriting loan sales for buyouts.

``Private equity has been an engine of growth for us and the industry in general,'' said Gary Crittenden, chief financial officer of Citigroup Inc., the biggest U.S. bank, on a July 27 conference call with investors. ``I would be stretching the truth if I said that our business plans anticipated what just happened in the past four to six weeks in the leveraged loans business and the potential impact that it could have on the private-equity market.''

Until last month, demand from investors was so strong that buyout firms were able to borrow with fewer restrictions, using so-called covenant lite securities and pay-in-kind bonds that allow companies to pay off debt by issuing new debt.

Yield Spreads
Investors have put the brakes on the LBO market, rejecting sales to fund buyouts of Auburn Hills, Michigan-based automaker Chrysler Corp. and Nottingham, England-based Alliance Boots Plc, the U.K.'s largest pharmacy chain. The companies failed to sell enough debt, leaving the banks stuck holding the loans while the buyout firms completed their takeovers.

Chrysler's German parent DaimlerChrysler AG last week said it would inject an additional $1.5 billion of debt to support the buyout.
``The high-yield market did a hop, skip and a jump and said, `We're not taking that stuff on those terms,''' said Frederick Joseph, managing director of New York-based Morgan Joseph & Co. and the former chief executive officer of Drexel Burnham Lambert Inc. ``The brokerage firms are getting stuck with some paper and it's going to take a while for it to get digested.''

Momentary `Blip'
The extra premium investors demand to own investment-grade corporate bonds over U.S. Treasuries widened 20 basis points to 128 basis points last week, according to data compiled by New York-based Merrill Lynch & Co. Spreads on high-yield bonds rose 91 basis points to 428 basis points, the highest since May 2005. A basis point is 0.01 percentage point.

``We're clearly going into a time of a very, very limited ability to access the lending market,'' said the 55-year-old Rattner of Quadrangle.
Cadbury had to delay the sale of its U.S. drinks unit because two groups of buyout firms weren't willing to meet the $15 billion asking price. The groups included Stephen Schwarzman's Blackstone Group LP in New York and Thomas H. Lee Partners LP of Boston.

``Some transactions came to market that pushed beyond what the debt markets were willing to do,'' said Scott Sperling, co- president of Thomas H. Lee, in a July 27 interview.

Scrapped Deals
While the pace of leveraged loans is slowing, the market will probably be ``back in business'' by October, Johnny Cameron, head of corporate and investment banking at Edinburgh-based Royal Bank of Scotland Group Plc, told reporters on a conference call on Aug. 3. Royal Bank earned almost $270 million from arranging leveraged loans in the first half, according to Freeman.

``Everybody's thinking about when the music's going to stop and I don't think we've hit that yet,'' said Ilan Nissan, a partner in the New York office of O'Melveny & Myers who works on buyouts. ``We're at a blip at this moment. Many people are saying `Let's take a breather and see what happened.'''

JPMorgan CEO Jamie Dimon, speaking on July 18, told investors that the drop in demand is ``a little freeze.''

That's sending a chill over the investment banks' shares. JPMorgan's stock slipped 11.5 percent in the past month, Deutsche Bank shares dropped 9.4 percent, and Credit Suisse fell 9 percent. Shares of New York-based Goldman Sachs Group Inc. declined 20 percent and Lehman Brothers Holdings Inc. fell 25 percent.

Lost Revenue
Investment banks in the U.S. and Europe are grappling with the loans they've underwritten for buyouts. They're carrying $400 billion of high-risk, high-yield loans they can't get other investors to take, according to Baring Asset Management in London. Companies have scrapped 46 debt deals worth $60 billion since June 22, Baring data show.

``Leveraged deals for private-equity will probably dry up until banks can clear up part of the backlog which will take at least until the end of September,'' said Toby Nangle, who helps manage $37 billion in assets at Baring Asset Management. ``As long as the conveyor belt is jammed, new fee revenues won't be forthcoming.''

Deutsche Bank is one of a group of banks on the line for the funding for KKR's takeover of Alliance Boots. The banks cancelled last week the sale of $2 billion of debt after failing to find investors, increasing the amount of debt the underwriters have been left holding to about $16.8 billion.

``Investors are taking a more cautious approach with respect to leveraged finance,'' Chief Financial Officer Anthony di Iorio told analysts on an Aug. 1 conference call. The bank took a ``not insignificant'' charge in the second quarter to mark down the value of some outstanding leveraged loans, he said.

Business Mix
Leveraged loans made up less than 4 percent of Deutsche Bank's total revenue during the past six quarters. That's less than JPMorgan, which netted more than 7 percent in 2006, and Credit Suisse, which received 7.5 percent of its total revenue from leveraged finance, according to estimates from Standard & Poor's.

As the pace of buyouts slows, not only will banks forgo revenue from underwriting loans, they may miss out on fees from advising on buyouts, according to Richard Barnes, a London-based analyst at S&P. For every dollar a bank earns in fees, it earns a further 50 cents in sales of other products, he said.

``A softening of investment banking performance was inevitable at some point,'' Barnes said. ``We're likely to see that in the third-quarter numbers.''