The Faber Report

Another Source of M&A Financing Comes Back


Collateralized Loan Obligations, better known as CLOs, are on the comeback trail, yet another sign that financing for leveraged buyouts is becoming increasingly available.

Negotiating Pay

CLOs buy leveraged loans from banks, which are then repackaged and sold as securities to investors around the world. When the credit crisis began in mid 2007, the CLO market dried up and financing for leveraged deals went right along with it.

No one is predicting a return to days of yore when banks were able to unload commitments to CLOs rapidly, allowing them to further new commitments to ravenous private equity buyers.

But with the leveraged loan market hitting a 21-month high in price and bankers telling me they are ready to make commitments of as-much-as $10 billion in financing for the right deal, there’s no doubt that after a more than two-year hiatus, private equity will again become a robust player in the M&A market.

How much of a player? That’s to be determined.

Return of the Leveraged Loan

At present, what merger and acquisition activity there is, is dominated by strategic buyers and that seems unlikely to change. In fact, while bankers may be getting brave when it comes to financing prospective private equity deals, the principals themselves are telling me they are happy to focus on deals between $2 billion and $5 billion.

Anything bigger than that would require a very sizeable commitment of equity from their funds given banks still want roughly a third of the deal to be comprised of equity.

And even in what the bigger private equity firms now see as their sweet spot, don’t be surprised to see competition from strategic buyers once a deal has been agreed upon. Corporations have access to even cheaper financing than pe firms which helps to make prospective returns from a deal worth the prospect of going hostile.

In late 2007, it was expected that a wave of bankruptcies would occur over many of the leveraged deals done between 2006 and 2007; this never really came down. Instead backing on, some of, these deals were written down aggressively by many of the banks that gave them. Yet leveraged loans still sharply climbed to a 21-month high this week.
According to a Citigroup report: leverage loan prices have increased 91.7 percent of face value this week, which is the highest since June of 2008. The low was 59 percent in December of 2008. Loan defaults are now down to a rate of 5.7 percent at the end of Q1 from a record 11 percent in November and forecasts now are down to a rate of 3 to 4 percent this year.

So, what does all this mean? The CLO business that dried up during the subprime mortgage crisis is now starting to inch back. The first CLO deal of 2010 was announced earlier this week. 

Now that the financing has arrived for leveraged buyouts (LBOs), will it be used and how?  Bankers tell me a particular deal could go as high as $10 billion. But my sources in private equity say it’s more likely to remain in the $3-5 billion range for right now. 

  • More on CLOs: Michael Lewitt, President of Harch Capital Management and author of the upcoming book, The Death of Capital, interviewed Thursday during The Faber Report explains how "the CLO market is starting to come back from the dead."



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