Funds affiliated with big-name buyout shops
A month ago, Carlyle Capital Corp., a Euronext-traded investment company that targeted fixed income assets including AAA-rated mortgages and credit products, defaulted on $16.6 billion in debt after it failed to reach an agreement with its lenders to put up more collateral for its aggressively levered investments. The fund has entered liquidation, and investors will in all likelihood receive none of their capital. Meantime,
By contrast, the parade of credit opportunity funds raised by sponsors—Buyouts has identified at least eight such funds that raised $13.5 billion—don’t seem to be in danger of collapse. But some have hit rough patches. On Feb. 22, Oaktree Capital Management, the Los Angeles-based investment firm, injected about $200 million of mostly its investors’ money into its
For the most part, these funds areconservatively structured, shying away from toxic residential mortgage-backed securities and using far less leverage than, say, Carlyle Capital Corp., which reportedly borrowed $30 for every $1 it invested in AAA-rated mortgage-backed securities.
Managers of Lehman Brothers’ Loan Opportunity Fund, which targets first-lien secured positions in LBOs in the new and secondary market, planned to leverage its investments 3.5x when it closed in October 2007, though it’s not using anywhere near that amount now. Similarly, Oaktree Capital’s European fund set out to use 3.5x to 4.0x leverage and is now typically employing 2.0x leverage; its
At least one limited partner, however, said leveraged loan investments in general are struggling. The
Fund managers remain positive, however. Our sources close to Oaktree Capital, for example, said the firm’s $4 billion Oaktree Loan Fund is almost fully invested and anticipating returns of 8.5 percent to 9 percent; the firm is also still confident its European Credit Opportunities Fund can generate returns in excess of 20 percent.
Lehman Brothers expects falling prices will allow it to buy debt on the cheap with its Loan Opportunity Fund, for which it raised $670 million. Lehman has deployed about half the fund. “It’s a good market if you’re a buyer and you have capital and capacity,” said Michael Guarnieri, a managing director who oversees the fund. But there is a shortage of quality paper, he said. “Sometimes your inability to buy paper you like is a challenge, even when the overall market is volatile.”
Prices for mid-market senior secured loans have increased about 25 to 50 basis points, from about LIBOR plus 450 to LIBOR plus 500, since Audax Group in December began reviewing investments for its
Guarnieri of Lehman Brothers and our sources close to Oaktree Capital said creditors are not pressuring their funds to put up more collateral.
Perhaps some of these funds jumped in the market a little too early, as New Jersey’s Cark suggests. The mark-to-market value of leveraged loans continues to drop, forcing Wall Street banks to seek out novel ways of ridding their balance sheets of loans they agreed to underwrite for big buyouts but haven’t been able to sell since the debt markets seized up. As these loans depreciate in value, they drag on banks’ income. “That’s what’s driving them crazy,” said one attorney.
One way banks are trying to unload the debt is by offering financing to potential buyers. A hypothetical scenario works like this: A buyer agrees to purchase $1 billion of debt, but only puts up a third of the price in equity. The bank cuts a new loan to finance the rest. In the process, the bank eliminates its exposure to the hung debt by a third, and the new loan reflects more favorable market conditions and contains better interest rates.
Citigroup is nearing an agreement to do just that. The investment bank, as of press time, was finalizing a deal to sell off $12 billion of its leveraged-loan portfolio to a handful of buyout firms. To facilitate the sale, Citigroup was prepared to provide financing to the group of LBO firms and sell the securities at a steep discount to par—at about 90 cents on the dollar. The investment bank is trying to eliminate the leveraged-loan exposure it built up in 2007, estimated at nearly $43 billion.
Banks aren’t just pitching these deal to hedge funds and other typical debt investors, which are more likely to negotiate better terms. Instead banks are pitching the deals to pension funds, insurance companies and other entities that don’t usually invest in such securities.
The idea doesn’t sound good enough to Audax Group, which has stayed away from such offers. “There’s a lot of volatility in that area,” McGonigle said. “It’s hard to say what the right entry point is for those loans. Some thought it was in October or November of last year, and then the market still had some downside.”
Another idea banks are kicking around are special purpose vehicles that would hold a group of loans, from which the bank could syndicate debt or equity interests to hedge funds and other buyers. That set-up is less likely, however, without a robust collateralized debt obligation market.