July 17, 2007
Stuck on You (High Yield Debt)
Bloomberg is reporting today that Goldman Sachs Group Inc., JPMorgan Chase & Co. and the rest of Wall Street are stuck with at least $11 billion of loans and bonds they can't readily sell. The debt is largely related to leveraged buy-out high yield notes which failed to garner buyers. At least six leveraged buyouts over the past month have failed to fully sell, including the debt to finance the acquisitions of U.S. Foods, Dollar General and ServiceMaster Co. (as well as Maxeda announced today). And, there may be more on the way. Bloomberg reports that only three of the 40 biggest pending LBOs are contingent on financing (i.e., an escape clause that permits the acquirer to terminate the acquisition if funding can't be arranged). If this financing is not bought the banks will be required to provide bridge loan financing or otherwise acquire this debt themselves.
For those looking for a halt to the private equity boom, this is one sign. A seizure in the high yield market is a certain way to stop private equity acquisitions. And the market is beginning to crack a bit. According to Merrill Lynch, high yield bonds fell 1.61 percent last month and regular debt fell 2.73 percent. Still, the high volume of successful acquisitions shows that there is still momentum in the market. But banks are likely to respond to this uncertainty by cutting back on offered terms in the future. They will likely no longer freely offer covenant-lite loans and toggles which provide buyers more flexibility in down times. Financing contingencies may also begin to appear more frequently in transactions. The end result is likely a bit of a slow-down in the private equity train, but unless something momentous happens there is not likely to be a full brake. Nonetheless, given the situation banks would also be advised to proceed with caution on committed financing and bridge loans lest they get stuck with a large amount of debt that they can't sell as First Boston Corp. famously did in 1989 with a bridge loan for a buyout of Ohio Mattress Co., the predecessor to Sealy Corp. The deal is known as the "burning bed", and First Boston only avoided bankruptcy by receiving a bail-out from Credit Suisse.
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