Dog eat dog

Private equity and investment banks make strange bedfellows. Late last year, Terra Firma’s Guy Hands referred to the banks that finance leveraged buyout deals as loyal dogs who whimper when they get hit and who need enticing out of their baskets where they lay licking their wounds over a reported US$300bn overhang of debt.

Hands, himself a former banker at Nomura and Goldman Sachs, later apologised for his remarks, but not before the loyal dogs sent him a box of dog biscuits and a note to use them sparingly with his bankers. Their second response was to investigate ways to shift some of that overhang from their balance sheets.

At the time, Citi was reported to be in talks with Kohlberg Kravis Roberts (KKR) to form an off-balance sheet vehicle for buying impaired loans arising from the credit crunch. The joint venture would involve US$5bn of equity and US$10bn of debt.

This was a surprise, as Citi would no doubt be near the front of the queue for those wishing to sell off their portfolios of loans, which included financing for the US$26bn takeover of First Data Corporation, a US e-commerce and payment solutions group, and the record-breaking US$45bn buyout of TXU, a US power business.

The buyer in both of those deals? KKR. And TPG for TXU. Talk of that JV now appears to be dead and instead, Citi is now the vendor in a US$12.5bn sale of its US$43bn loan portfolio in order to reduce its balance of debt. KKR is not a buyer but TPG, on the other hand, is – along with buyout behemoths Blackstone and Apollo Management.

Deutsche Bank is now following suit and is attempting to clear its lines of somewhere in the region of US$55bn of LBO loans – a quarter of the US$200bn of loans still on the books of global banks at the end of 2007 according to BNP Paribas – and has put a US$5bn–$8bn leveraged loan portfolio up for sale (see p.15).

Deutsche Bank’s portfolio of loans includes the US$17.1bn buyout of US casino group Harrah’s Entertainment by – here boy! – TPG and Apollo Management; and the £11.1bn take-private of UK retail chain Alliance Boots by – fetch! – KKR. Proof, if any were needed, that private equity is relentless and can adapt to any market. And that you couldn’t make this stuff up!

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.

One package of loans that won’t make it out of the doggie bowl, though, is the £2.4bn provided by Citi for last year’s £4bn purchase of EMI. By Guy Hands’ Terra Firma. The bank’s largest single exposure was pulled from the menu after uncertainty about Terra Firma’s restructuring of the UK music group and the financial results of that overhaul.

That private equity firms can profit from buying these loans is not in doutb, the returns are fantastic and the risks are low – leading to another doggone certainty – that the banks will keep whimpering and private equity will keep hitting them while simultaneously tickling their tummies.