Banks Test Options To Reduce Exposure

By Donal O’Donovan and Stephen Carter

Although there is not enough primary liquidity available to sell a billion dollar-plus buyout, arrangers were able to place a $1 billion chunk of Allison Transmission’s $3.5 billion loan facility in the secondary market earlier this month. The success of this strategy—to propel a buyout from The Carlyle Group—is leading bankers to ask whether bite-size chunks are enough to reopen the market.

The leveraged finance market is in a state of stasis. With liquidity slashed, the market for primary deals cannot match banks’ hopes of getting underwritten deals off balance sheets. In addition, an unsettled after-market and a seemingly unbridgeable bid-offer spread make secondary trading, and the secondary sell-down of the overhang, extremely difficult.

Despite these difficulties, bankers are hoping Allison Transmission’s successful placing earlier this month could herald the beginning of a thaw between buyers and sellers.

Citi, Lehman Brothers, Merrill Lynch and SMBC sold the $1 billion slug of Allison Transmission’s senior secured term loan for 96 cents on the dollar. The deal is believed to have been well placed with a good cross-section of 25 accounts, and it quickly traded up above 99 cents.

Market watchers are citing such the Allison deal—and a pending sale of a slice of the $24 billion Kohlberg Kravis Roberts & Co.’s bankers have underwritten for the First Data Corp. LBO—as examples of how the market will be operating over the next few months. “[The deals] will come cheaply to create demand, but only a portion will be sold to develop scarcity value,” a loan syndicate official said.

The strategy cuts exposure but remains a test of balance sheets. Arrangers hope a series of successful deals could slowly rejuvenate the market, but maintaining discipline could prove difficult as banks face year-end reporting. Indeed, despite their interest, investors still want to buy at discounts of three or four points below where banks are willing to sell.

“Everyone is waiting to buy cheaply,” a trader said, “and there is talk investment banks are going to be more active in clearing some of their backlog in the run-up to year-end reporting.”

The approach taken with Allison is only relevant as long as banks can afford to hold deals and continue to record losses if they are marked to market. But investors face tough choices too, faced with the prospect of how long they can afford to suffer the opportunity cost of not investing.

“The best scenario now is of a gradual reduction in risk,” said one investment banker. “No one will push the market for the next six to nine months.”

The primary market is now about behind-the-scenes negotiations as banks attempt to sell down their holdings. Banks will try to parse out different pieces of the capital structure and sell those that meet demand. This deliberate, methodical approach will also include partial sales and block sales.

With around a global $400 billion of leverage loans and high-yield bonds on banks’ balance sheets, only the most attractive credits will be used to test market appetite—and only once they’ve been scrubbed and polished to maximize appeal. Even selling down a third of the overhang will leave banks exposed on a vast amount of debt deals.

Donal O’Donovan and Stephen Carter cover leveraged lending for IFR, a sister publication.