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Leveraged Buyouts on Hold Until 2008 as Crunch Worsens

A worsening credit crunch and its broad impact on financial markets has some dealmakers predicting that leveraged buyouts are on hold for the rest of the year and perhaps well into 2008.

When banks essentially cut off lending to private equity firms about a month ago, Wall Street hoped the LBO market would return sometime after September. Investors would again buy loans from banks and clear the logjam that has made new deals difficult to arrange -- or so the thinking went.

But in the last few weeks, the private equity industry has become painfully aware that banks will probably be stuck with a solid chunk of the $330 billion of debt they're waiting to offload, limiting their lending ability.

To make matters worse, the subprime fallout has only steepened in the last few weeks, squeezing the commercial paper market, hedge funds and several publicly traded companies.

That has tightened the vise grip on lenders. As a result, some say that, barring another major move by the U.S. Federal Reserve, there won't be any buyouts with heavy debt -- a signature component of the previous private equity deal frenzy -- until well into next year.

"We're in the midst of a major, major credit crunch," said an investment banker at a large commercial bank that arranges and finances private equity deals.

"No LBOs as we've come to know them will be financed for the remainder of the year," added the banker, who requested anonymity.

Private equity firms have hundreds of billions of dollars on hand, and they will be spending it in the next three to six months, experts say.

Minority stakes, cash-only deals, debt investing are all options. But the days of cheap and easy debt for LBOs are gone, bankers say, at least for now.

"I don't think there will be any significant LBO activity for at least six months," said a top M&A banker at a major investment bank.

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During the LBO frenzy of the last two years, banks kept their balance sheets low on debt by selling the securities to hedge funds and other investors starved for high-yield paper. But the buyers have vanished.

Part of the problem for banks is that they need to adjust the values of the loans on their books on a daily basis, a requirement known as marking to market.

This has added to pressure on the banks and made the debt backlog all the more difficult for them as the credit crunch has pushed down the value of those loans.

The debt clogging their balance sheets has severely cut the ability of banks to lend money for new M&A deals.

"There are a number of our competitors who overextended themselves and now find themselves in a position where they are trying to offload what they've got and not take on new commitments," said a third investment banker.

Investment banks grappling with the debt bottleneck include some of the biggest dealmakers out there: Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynchand Bear Stearns. According to a recent Citigroup note, those brokers have $75 billion worth of loans allocated to them out of that $330 billion LBO backlog.

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The so-called commercial banks, which include competitors Bank of America, Citigroup, Deutsche Bank, JP Morganand UBS, are not under the same type of pressure. Their larger balance sheets give them more breathing room to hold onto the loans and wait for better market conditions.

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They also have accounting rules in their favor, as commercial banks can account for their loans either as "available for sale" or "held to maturity," under generally accepted accounting principles. Loans that are "available for sale" must be marked to market daily, but those under "held to maturity" do not.

Still, even commercial banks that helped finance the more than $700 billion of announced leveraged buyouts so far this year are now reluctant to fund deals with even a modest amount of debt, investors and bankers say.

But not everyone thinks the private equity sky is falling.

"We've had LBOs for 30 years; they're not going to evaporate in 30 days," said Michael Ryan, a Cleary Gottlieb private equity lawyer. "We've seen this happen before. What always happens is that the market settles. The market had gone too far one way, and it's adjusting."

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