If you thought the debt market would have trouble digesting the First Data deal, wait till it gets a plateful of TXU ( TXU). A person close to the deal says banks next week will launch the sale of loans to finance the $32 billion buyout of TXU, a big Texas utility. Kohlberg Kravis Roberts and TPG Capital are buying TXU in a deal underwritten by banks led by Citigroup. The underwriters will be looking to capitalize on the momentum started by the First Data deal. The question is whether the market has enough of an appetite to scarf down another big helping of this stuff. Investors have been heartened by last month's sale of $9.4 billion worth of debt backing the leveraged buyout of First Data. The deal was the first mega-buyout funded in the debt markets since this summer's credit crunch, and it eased fears that financing shortfalls would wash out a slate of huge deals. Indeed, the First Data underwriters seemed to orchestrate the impossible. They ended up selling nearly twice as much debt as they originally planned, without having to resort to the cheap leverage they were initially considering dangling to entice buyers. The question now is whether the success of the First Data deal will doom future megadeals to failure. The First Data underwriters succeeded in part by reaching beyond the typical buyers of risky debt to a new audience, while holding prices at respectable levels. But without lowering prices or drawing in the regular buyers of this sort of paper, the banks may find there's not enough demand to fund the huge TXU deal. To watch Liz Rappaport's video take of this column,
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"The market is in a tenuous spot," says Meredith Coffey, director of analysis at Reuters Loan Pricing Corp. The First Data banks faced a number of challenges that may reappear once the TXU deal is launched. First, they had to entice atypical buyers to fill the hole created by the now-marginalized collateralized loan obligation buyers. CLOs are pools of loans that banks sell to investors in part by getting a higher credit rating than the underlying assets. CLO issuance virtually dried up this summer as structured products tied to mortgage backed securities sparked investors to re-evaluate the credit quality of the underlying assets. Typically, about 60% or more of any leveraged loan deal in the past was placed with CLOs, says Chris Donnelly, director at Standard & Poor's Leveraged Commentary & Data. He says about 20% of the First Data loans was dealt to CLO buyers. The bulk of the remainder was crossover high yield bond buyers, he says. But these investors remain anxious about pricing. How anxious? The First Data loans came with the provision that if Credit Suisse sells more loans within the next year at a lower price, they'll be paid the difference. Also, some traditional high yield bond investors have mandates that limit them to a limited portion of loans, relative to bonds, in the portfolio.
If the crossover buyers disappear, the banks might have to lower the pricing on the deals to attract the much-ballyhoooed billions and billions raised for credit opportunity funds. These funds, meant to take advantage of low-priced junk loans or bonds, "have not arrived," says one loan fund manager who declined to be named. "The credit opportunity funds are interested in deals at 92, not at the sell-side's 96, 97 offer," says Donnelly, referring to cents on the dollar of principal amount. But 92 is too low for the banks, particularly in the context of their recent writedowns. Donnelly notes that Citigroup ( C) and Morgan Stanley ( MS), at least, are effectively using 96 as the markdown price for loans left on their balance sheets. Citi and Deutsche Bank ( DB) this week took multibillion-dollar writedowns, at least partially on the value of LBO loan commitments. The banks will have more writedowns and more answering to do to shareholders unless they avidly defend that 96 floor on loan prices. Market participants say Credit Suisse, at least, has done just that. One investor claims CS made it clear shortly after the loans priced that they were willing to buy large chunks to make a market at over 96 cents on the dollar, up to $100 million.
Of course, there are reasons to believe there will be demand for some of the forthcoming deals. Bond investors have collected cash through coupon payments and maturing debt throughout the summer, with barely anywhere to reinvest it. Liquidity completely dried up in July and August. When the credit crunch started to wane, junk bond investors quickly exhausted the so-called bargains in their own secondary market in September, sending risk premiums back down. Now, with virtually no new deals on the new issues calendar, many are turning to the loan market for bargains, say loan market participants. Some bond investors who are bearish on the economy are also increasingly attracted to loans. In the case of default or bankruptcy, loans are repaid first, ahead of bonds. Still, recall that for all the relief about the success of the First Data deal, there is still over $10 billion in First Data debt left to place with investors. Then add TXU's $25 billion of debt to place and, just for fun, the huge slug of debt financing BCE's ( BCE) $51 billion buyout. The reception TXU gets should show how hearty the debt market's appetite really is.