Four of KKR’s CLOs holding about $7 billion of loans are breaching this tes
Sunday, March 15th, 2009With the average CCC ranked loan quoted at 36.5 cents on the dollar, 147 of 557 CLOs monitored by Wachovia Corp. are violating terms requiring a minimum amount of collateral.
KKR Losses Show Failure to Close Gap Raising Defaults (Update1)
By Pierre Paulden and Neil Unmack
March 13 (Bloomberg) — Investment funds that purchased a majority of the lowest-rated loans during the credit boom have stopped buying, threatening to undermine President Obama’s plan to pull the economy out of the worst recession since 1982.
The funds, known on Wall Street as collateralized loan obligations, provided cash to movie-rental chain Blockbuster Inc., which is now exploring a bankruptcy filing, according to a person familiar with the situation. They also helped finance the $33 billion buyout of Nashville, Tennessee-based hospital operator HCA Inc.
Now, as an economic slowdown drags into the 16th month, borrowers unable to pay their debts are causing record losses for CLOs. Moody’s Investors Service put 760 of the funds, holding about $440 billion of assets, on review for downgrades on March 4. Unless policymakers decide to earmark some of the $11.6 trillion of government programs created to combat the seizure in credit markets to support high-yield loans, defaults may soar through 2012, according to investors.
“The game is over,” said Ross Heller, managing director at New York-based NewOak Capital LLC, an investment and advisory firm. “There isn’t going to be money available for refinancing. Companies will have to be put into bankruptcy and the debt restructured.”
As credit losses have climbed, issuance of so-called leveraged loans in the U.S. plummeted to $11.7 billion in January and February from $66.3 billion in the first two months of 2008 and $158.7 billion for the same period in 2007, according to data compiled by Bloomberg.
Below Investment Grade
The Federal Reserve said March 3 it may include CLOs in its bailout programs, though none of the commitments for stimulus and lending is designed to deal with loans to the neediest companies.
CLOs, a type of collateralized debt obligation, pool below investment-grade loans and slice them into securities of varying risk and return. The leveraged loans are rated below BBB- by Standard & Poor’s and less than Baa3 at Moody’s and are defaulting at a 4.5 percent rate, the fastest since November 2002, according to data from S&P’s LCD.
The S&P/LSTA U.S. Leveraged Loan 100 Index has fallen to 62.1 cents on the dollar from 100.3 cents in June 2007. The decline contributed to the $1.2 trillion of losses and writedowns by global financial institutions since the start of 2007.
Blackstone Group LP wrote down to zero the value of billions of dollars of loans it bought last year from Deutsche Bank AG, according to a person familiar with the decision.
Biggest Buyouts
Henry Kravis’s KKR Financial Holdings LLC, a publicly traded finance company whose shares have fallen 97 percent in the past year, reported a $1.2 billion loss on March 2. That included charges for loans held in its CLOs to bankrupt Chicago-based newspaper owner Tribune Co.
Kravis, his cousin George Roberts and Jerome Kohlberg started Kohlberg Kravis Roberts & Co. in 1976 and were pioneers in leveraged buyouts, where investors acquire companies mostly with borrowed money. KKR participated in the largest deals, ranging from the $31.4 billion acquisition of RJR Nabisco Inc. in 1989 to the $43 billion purchase of Dallas-based electricity producer TXU Corp. in 2007.
In 2004, Kravis and Roberts started KKR Financial to buy mortgage securities and high-yield debt, giving them the opportunity to invest in financings for new deals as the buyout boom crested in 2006 and 2007 when LBO firms made $1.4 trillion of acquisitions, according to Bloomberg data.
Market Unravels
The market began to unravel in July 2007, just as bankers tried to find investors for credit they provided in KKR’s 11.1- billion-pound ($15.6 billion) purchase of Alliance Boots Holdings Ltd., the owner of Britain’s biggest drugstore chain. Deutsche Bank AG, JPMorgan Chase & Co. and other banks were forced to delay selling 8 billion pounds of loans for the takeover, becoming the first deal frozen when credit markets started to seize up.
Lower loan prices and companies reneging on their debt agreements are causing losses on the CLO securities held by banks, insurance companies and hedge funds.
“Corporate default rates are likely to greatly exceed their historical long-term averages and reflect the heightened interdependence of credit markets in the current global economic contraction,” Moody’s analysts said in a March 4 report. The New York-based ratings company said it may downgrade 3,600 portions of 760 CLOs. The action affects $100 billion of such securities and excludes only the top-ranked portions of the funds.
While the Fed said its Term Asset Backed Securities Loan Facility, or TALF, may be expanded to CLOs, the program will first buy $200 billion of auto loans, credit cards, student loans and loans guaranteed by the Small Business Administration.
‘Next Focus’
“CLOs should be the next focus for the TALF,” said Randy Schwimmer, a senior managing director of Churchill Financial LLC in New York, a lender that also manages more than $3 billion of the debt pools. “Commercial lending needs to be supported.”
Without demand from CLOs, companies are paying higher rates for loans, Schwimmer said.
When Sirius XM Radio Inc., the New York-based satellite broadcaster, extended the maturity of $350 million of loans due in May by one year, it agreed to pay lenders a 15 percent rate, according to a regulatory filing March 6. Sirius’s $250 million revolving credit had a maximum interest cost of 5.25 percent, and the $100 million term loan paid 5.56 percent as of Sept. 30, according to a Nov. 12 filing.
Higher Returns
Investors bought CLOs because they had higher returns than similarly rated securities. The $58 million AA ranked portion of KKR Financial CLO Ltd. sold in March 2005 offered investors interest of 45 basis points more than benchmark bank rates. That compared with a spread of as little as 36 basis points for companies of the same grade, according to Merrill Lynch & Co. indexes. A basis point is 0.01 percentage point.
As cash flowed into CLOs, the funds bought almost two-thirds of the debt that financed the record $616 billion of leveraged buyouts in the first half of 2007, S&P LCD data show. Between 2002 and 2007, they accounted for 60 percent of term loan purchases, according to S&P LCD.
Until the credit markets seized up in late 2007, private equity firms, including Blackstone and Carlyle Group, formed teams to manage CLOs. They earn revenue by charging fees and buying stakes in funds they oversee.
“They opened up the buyer base and enabled leveraged finance debt to be purchased by the far-larger investment-grade universe,” said Chris Taggert, an analyst at debt research firm CreditSights Inc. in New York.
HCA Loan Sale
Demand from CLOs and other credit funds helped Georgia- Pacific LLC, a unit of Koch Industries Inc., raise a $5.25 billion term loan in January 2006. The loan is the sixth most- widely held in CLOs, JPMorgan data show.
The following November, Bank of America Corp., Merrill Lynch, JPMorgan and Citigroup Inc. sold an $8.8 billion term loan, the largest at the time, and the third-most included in CLOs, to back the HCA buyout. The hospital operator was sold to KKR, Bain Capital LLC, Merrill Lynch and Thomas Frist Jr., co- founder of the company.
CLO sales fell to $17 billion in 2008 from $100 billion in 2006, Moody’s data show, as investors refused to buy securitized debt.
A record low in loan prepayments also means that managers are getting less cash back to reinvest in new debt. Prepayments fell to 8.8 percent last year, less than a quarter of the rate a year earlier and a fifth of the average since 1997, when S&P starting tracking the data.
“The absence of new CLOs magnifies the chance companies won’t be able to refinance debt,” said Kevin Cassidy, vice president and senior credit officer at Moody’s.
Blockbuster
Blockbuster, which has a $350 million bank line maturing in August and a $352.1 million term loan due two years later, may need to file for bankruptcy, according to the person familiar with the situation. The Dallas-based company has hired law firm Kirkland & Ellis LLP for refinancing and capital-raising initiatives and doesn’t intend to file, spokeswoman Karen Raskopf said.
R.H. Donnelley Corp., a yellow-pages publisher, has “large debt maturities beginning in early 2010,” Steve Blondy, chief financial officer, said on a call with investors March 12. The Cary, North Carolina-based company planned to refinance the debt, “which may not be possible in the current capital markets,” he said.
The publisher has $2.2 billion of loans and bonds maturing through 2011, Bloomberg data show. It plans “to initiate discussions with our banks and bondholders about amending, refinancing or restructuring our debt obligations,” Blondy said.
Coming Due
About $26 billion of bank loans and bonds come due in 2009, with a further $44 billion in 2010 and $120 billion in 2011, according to Moody’s.
“The good news” is companies took advantage of cheap rates between 2004 and 2007, and that debt doesn’t need to be refinanced immediately, said Vivek Tawadey, head of credit strategy at BNP Paribas SA in London. Those risks will grow beginning in 2011, when the largest buyouts in history need to start rolling over debt, Taggert said.
Georgia-Pacific has $3.1 billion of loans maturing by 2011. HCA, which has $12 billion of bank lines maturing in 2012 and 2013, may struggle to refinance in the weakened loan market, according to Lauren Coste, an analyst at Fitch Ratings in Chicago.
James Malone, a spokesman for Atlanta-based Georgia-Pacific, declined to comment. HCA spokesman Ed Fishbough didn’t return calls.
Lost Value
A return of the CLO market is unlikely because the existing securities have lost so much value, said NewOak’s Heller, who doesn’t agree that the government should support the high-yield debt.
“CLOs created the problem of too much debt at these companies,” he said. “You need to get through it, not keep the patient on life support.”
The CLO bonds rated AA are trading at an average of 25 cents of face value, according to a March 2 report from JPMorgan.
The riskiest bonds are worth less than 10 cents on the dollar as the amount of borrowers with the lowest credit grades has increased to a record 10.8 percent from 5.7 percent at the end of the year, according to S&P.
That’s because CLOs can typically hold no more than 7.5 percent of assets rated below CCC+. After crossing that threshold, the fund has to value the assets at market prices.
Breaching Terms
With the average CCC ranked loan quoted at 36.5 cents on the dollar, 147 of 557 CLOs monitored by Wachovia Corp. are violating terms requiring a minimum amount of collateral.
Breaking these rules may force managers to shut payments off to the riskiest portions of the fund and divert cash to repay the safest bonds, Heller said.
Four of KKR’s CLOs holding about $7 billion of loans are breaching this test and paying down senior notes, according to a regulatory filing by the New York-based firm March 2. KKR spokesman Peter McKillop declined to comment.
If company downgrades to the lowest ranks reach 40 percent, managers will have to dump holdings, further depressing loan prices, according to Kyle Bass, the managing partner of Dallas- based Hayman Advisors, who made $500 million in 2007 betting on losses from subprime mortgages.
“The unintended and dangerous consequence of these defaults would be an evaporation of the CLO bid,” Bass wrote in a letter to investors this month. “Now is not the time to enter this space.”
To contact the reporters on this story: Pierre Paulden in New York at ppaulden@bloomberg.net; Neil Unmack in London nunmack@bloomberg.net
Last Updated: March 13, 2009 10:43 EDThttp://www.bloomberg.com/apps/news?pid=20601109&sid=akXjReT2YryA&refer=news
