Area's Big Financiers Brace for 'a Serious Shakeout'

By Thomas Heath
Washington Post Staff Writer
Friday, August 10, 2007

The Washington region has become fertile for the financial industry over the past couple of decades, home to giants such as Fannie Mae, Carlyle Group and investment bank Friedman, Billings, Ramsey. Mid-level lenders such as Allied Capital and CapitalSource grew up here. There's even a crop of venture capital and private-equity spin-offs, including Thayer Capital, Arlington Capital Partners and RLJ Equity Partners.

Yesterday's 387-point drop in the Dow Jones industrial average, precipitated by concerns about a global squeeze on credit, left area financiers bracing for the fallout to hit locally.

Even Carlyle felt the jitters, as financing worries surfaced over one of its biggest deals.

Most lenders have been generous with credit in the past few years. But some of the riskier loans are going sour. The concern is that the malaise will spread through the economy.

"This is the real deal," said Eric F. Billings, chairman and founder of Friedman, Billings, Ramsey. "No question about it. This is a serious shakeout. You had a lack of discipline because of the huge excess of liquidity the past five years. That is working its way through the system right now."

William L. Walton, chairman of Allied Capital, which invests in small and mid-size businesses, said "the market is repricing risk. And given the complex structures that have been used to hold financial assets and manage credit risk, the market is trying to sort out who are the winners and who are the losers."

Yesterday, the market tried to parse the implications for one of Carlyle's deals.

Home Depot, the Atlanta home improvement retail giant, announced that it was renegotiating the terms of the $10.3 billion sale of its internal supply arm, HD Supply, to a group of private-equity firms that includes Carlyle, Bain Capital Partners and Clayton, Dubilier & Rice. Home Depot said the discussions could result in a lower purchase price or changes to the terms and financing of the transaction. Carlyle declined to comment.

"What is clear is that in a very short period of time, debt markets have slowed the ability for deals to happen," said David Schick, an analyst with Stifel Nicolaus. "It's harder to raise money, and harder to raise money at the rate you thought you could raise debt. These deals are always subject to market conditions."

Some of Wall Street's biggest banks are committed to financing more than $20 billion in Carlyle deals, according to private-equity insiders, but the current market has scared away potential buyers of that debt.

So if the banks can't sell that Carlyle financing, they can hold the loans themselves and hope to sell them later. Or the banks could walk away from a deal, for which they would pay a company like Home Depot a huge breakup fee. The most likely outcome is for Carlyle, which is known to have a good relationship with banks, to accept stiffer terms from its lenders. The stricter language would help make banks' customers more comfortable that the loan would be repaid, thereby allowing the deals to proceed.

Carlyle has several large deals pending, including its $6.3 billion acquisition of nursing-home giant Manor Care and a $2.7 billion agreement to buy Sequa, a conglomerate that makes products as varied as After Six tuxedos and metal coatings. The value of those deals, which are slated to close by year-end, could be reduced, and further deals are likely to come more slowly.

"The private-equity world is going to have to slow down very meaningfully for a little while," Billings said. "The pricing of transactions and leveraged buyouts are going to have to change substantially."

Walton estimated that the purchase price of companies could drop from around nine times earnings to seven or eight times earnings.

Frederic V. Malek, who was a senior adviser to Carlyle from 1989 to 1991 and then founded Thayer Capital, said the effect on Washington would be less severe than on other financial centers.

"The Washington area has been generally resistant to large swings because of the stability of government employment and spending," Malek said. "This is likely to settle down in the coming weeks or months. And I suspect that this will have a lesser effect in Washington than in the rest of the country."

Perhaps the most high-profile deal pending in the Washington area, the planned buyout of student-loan leader Sallie Mae, is not jeopardized by trouble in the debt markets, a source close to the prospective buyers said. The buyers have lined up commitments for the billions of dollars of financing needed to complete the purchase, said the source, who spoke on the condition of anonymity for lack of authority to comment publicly.

Capital One Financial, one of the Washington area's biggest financial companies, is less vulnerable than it was during the last credit crunch because its recent bank acquisitions make it less reliant on the sale of bonds to raise money, said Scott Valentin, an FBR analyst. The big credit-card issuer now has access to money through bank deposits, Valentin said.

Another high-profile private-equity deal involving a Washington company was a proposed $8 billion purchase three months ago of Harman International Industries, the multibillion-dollar manufacturer of high-end sound equipment. The company was founded 50 years ago by Sidney Harman.

Harman, who structured the deal so shareholders could roll their stock into the new, privately-owned entity, said yesterday that the deal with Kolhberg Kravis Roberts and the private-equity arm of Goldman Sachs would go through despite the credit turmoil.

"I expect it will have no effect on our closing," Harman said through a spokesman. The sale is expected to close in the fall.

Staff writer David S. Hilzenrath and staff researcher Richard Drezen contributed to this report.