Banks Chop $100 Billion Off Backlog Of LBO Financings As High-Yield Bond Issues Come Back In Demand

Global Finance, Dec 2007 by Platt, Gordon

As of early November, some financial institutions were still having problems rolling over commercial paper, and central banks around the world were still pumping extra liquidity into the markets. "As we start to roll into year-end, write-downs rule the roost, and accountability seems to be the order of the day," Gyan Sinha, senior managing director and head of asset-backed fixed-income research at Bear Stearns, wrote in a recent report. "The true nature of the possible losses from 2006 and early 2007 vintages is only now beginning to be recognized in the potential writedowns," he said. "The story of this year has been of smart, savvy accounts making an ill-timed entry into markets and falling into the trap of calling a bottom too early."

Bank Capital Tied Up

The next chapter in the subprime mortgage saga almost surely will cover subprime s impact on the capital of money center banks, broker/dealers, monoline bond insurers and others still strapped with risk, says Steven Abrahams, senior managing director and head of global liquid product strategy fixed-income research at Bear Stearns. "Losses have eaten into some capital already, and illiquid positions in remaining risk could keep capital tied up well into 2008," he says. "Unfortunately, the debate over the right value for mortgage debt probably will continue well into next year."

The lingering uncertainty likely means that most participants in the market will try to conserve capital, lower risk or do both, Abrahams says. "That probably means less room for holding positions in some securities, more hedging, less willingness to finance purchases," he says.

In September and October, banks sold more than $70 billion in pass-throughs to raise cash in lieu of selling positions in distressed credits, according to Abrahams. If there is any good news, it may be that the picture of risk and value should be clear by the end of 2008 at the latest, he says. "By that point, most of the weakest subprime loans will have reset, the impact of loss-mitigation efforts should be obvious, the results of foreclosure easier to predict," he says.

A potential worry for the long end of the yield curve is that the declining dollar continues to eat into the returns of foreign investors, Abrahams says. This could diminish foreign demand for US debt and push up longer yields, he says.

LBO Financings Go Ahead

In the high-yield bond market, Energy Futures Holdings, the former TXU, and its subsidiary Texas Competitive Electric Holdings sold $7.5 billion in a three-part note sale on October 24. The proceeds will fund a portion of the TXU leveraged buyout by a group led by Kohlberg Kravis Roberts and TPG On February 25 the investor group signed a definitive agreement to acquire TXU in a transaction valued at about $46 billion.

Texas Competitive Electric Holdings sold $3 billion of senior notes priced at par to yield 10.25%. Goldman Sachs, Morgan Stanley, Citi, JPMorgan, Lehman Brothers and Credit Suisse were the joint lead underwriters.

Energy Future Holdings sold $2.5 billion of 11.25% 10-year senior toggle notes priced to yield 11.625%. It also sold $2 billion 10.875% 10-year senior notes, which were priced at par.