Loss leaders?

Following the lead of Citi, Deutsche Bank has put a US$5bn–$8bn leveraged loan portfolio up for sale to pare its exposure to LBO-backed debt. RBS has also been actively marketing parts of its backlog over the past few weeks and has significantly reduced its long positions on 2007-era deals. Both banks are major players in leveraged finance, and the concessions are indicative of capitulation.

RBS, among the most active underwriter of new leveraged loans in Europe, needs capacity to continue underwriting new business. Moreover, it is under greater pressure to stabilise its own capital structure [see Equities news]. Deutsche Bank also aggressively courted buyout firms at the height of the LBO boom and still had €36.2bn of leveraged finance exposure on December 31. The total includes €15.3bn of funded positions and €20.9bn of unfunded commitments.

Other banks have stepped up the dialogue regarding the potential sale of their holdings as well, though less publicly. “We have been talking to banks all the time but there is a new momentum to the market,” said one institutional investor in Europe.

The Deutsche Bank portfolio is being marketed to at least 15 private equity shops as well as other institutional investors. Ares, PIMCO, Apollo Management, TPG Capital and Blackstone Group, some of which were also involved in the Citi bidding, are among the interested buyers, according to market sources.

The portfolio includes bonds and loans backing US deals such as Huntsman/Hexion, Harrah’s Entertainment, Penn National Gaming, CDW, Ceridian, US FoodService and First Data. European holdings such as Actavis as well as long positions in transactions that were syndicated but closed undersubscribed are also being shopped.

RBS is marketing €100m-plus tickets on its holdings to about two dozen accounts, mainly with links to US private equity. Its backlog includes BTC, Camaieu, Flakt Woods, Samsonite and Brakes Group, and ABN AMRO-legacy deals Maxeda and Hema.

Significantly, the current round of deal making includes holdings that have been syndicated as well as commitments that have not, according to one investor that is actively buying European credits. That may point to the erosion of previously solid syndicates, potentially pressuring other banks to break ranks as well.

The holdings up for sale include the largest European stuck deals of 2007 – the likes of Bassell, Alliance Boots and Saga AA. These remain tied up in syndicate agreements. While all the parties contend that they have held firm, this solidarity could unravel as the pace of selling gains momentum.

The most active buyers in the current market are credit opportunity funds set up by private equity firms and hedge funds to specifically target performing debt offered at deep discounts. A small number of new CLOs are also active.

For banks, the situation is certainly far from ideal. Not only are they selling assets at discounts but buyers are being offered the opportunity to buy specific deals, allowing them to cherry-pick higher-quality assets.

Cost of funding

Like Citi, which has extended US$9.5bn of credit to the buyers of its portfolio, favourable financing and terms are being made available to buyers. Banks prepared to extend credit, which in at least some cases includes first-loss guarantees, are doing so on a view that the loans will remain strong as individual credits.

Deutsche Bank, for example, is understood to be offering leverage at L+100bp to buy loans offered in the mid-to-high 80s. It is expected to complete the sale of the portfolio before the end of its second quarter on June 30. RBS is understood to be offering total return swaps (TRS) lines and credit-linked notes (CLN) to investors looking to leverage their investments, though not all buyers are opting to avail themselves of financing.

“By selling at anything that resembles the current trading levels, banks are taking losses,” suggests a senior banker at one of the firms involved. “The positive is that they are cleaning up their balance sheets and freeing up capital to underwrite new deals.”

Other market sources are less convinced as to the true motivations for the sell-downs. “It is an option for banks with capital problems,” according to a banker away from the situation. “So far, we have resisted doing this. It doesn’t free up that much capacity and means giving away future upside.”

Sponsors themselves are unfazed by the idea of rival private equity houses holding their debt. “Debt on the large LBO deals tends to have been so widely syndicated that that’s not really an issue because the individual holds involved are not large enough to be really meaningful,” suggests one US sponsor.

In any case, free transfer language means sponsors have no real say over who holds debt.

In fact, some sponsors have been buying up debt backing their own deals. French sponsor PAI is understood to have bought part of the €325m second-lien tranche of Lafarge Roofing at 65. Danish telco TDC, which was bought by an Apax-led consortium in 2006, has bought back hundreds of millions of euros in the secondary market. Such purchases could create un-leveraged returns equal to historical returns on equity from an LBO or, in the case of TDC, significantly reduce financing costs.

In practice, sponsors are only hampered by internal mandates that limit exposure to any one credit when it comes to buying debt associated with their own portfolio companies.

However, scepticism remains regarding the notion that the accelerated pace of selling will draw a line under the credit crisis of the past year. Goldman Sachs’s sell-down of €100m of debt backing Bain Capital’s buy-out of Bavaria Yachtbau at a price of just 65 highlights just such a risk. Investors that have circled patiently awaiting a fire-sale of credit assets are beginning to smell blood in the water.