Tight Credit Could Stall Buyout Boom

Now four months later, the Sallie Mae acquisition is facing difficulties and none of the other deals have happened. On Thursday and Friday, as the market scrambled to cope with the global credit crunch problems, Sallie's share price fell about 3 percent.

One problem with the deal is that it is being funded with $16.5 billion in debt. Borrowing that amount of money was cheaper earlier in the year. But it is far more expensive now because the credit markets are more sensitive to risk and are less willing to issue loans with generous terms and low rates, noted Richard Hofmann, analyst at CreditSights, who has followed the Sallie Mae situation closely.

"We believe [J.C. Flowers] wants to walk away because of what's happening in the credit markets," Hofmann said.

A person who spoke on the condition of anonymity because he is not authorized to speak publicly about the deal said that J.C. Flowers is fighting to back out of the deal or at least lower its price. A J.C. Flowers official declined to comment Friday, while a spokesman for Sallie Mae said the firm expects the buyout to close in October.

As deals stall, the two most powerful players on Wall Street that rode the buyout wave to riches -- investment banks and private-equity firms -- are suddenly locked in a contentious battle over who is going to pay for the mess.

"It's kind of a game of chicken right now," said Greg Peters, chief credit strategist at Morgan Stanley. "There is not a lot of give and take going on, and ultimately that's what you are going to need."

The problem is that large investment banks, including Lehman Brothers, Goldman Sachs, J.P. Morgan and Morgan Stanley, have committed to provide money for private-equity firms to make these deals. They were willing to do this because in the past they could slice and dice these loans into pieces and sell them to hedge funds and other investors around the world, including major financial institutions in Japan, France and Germany.

It was the willingness of these investors to take on these pieces of debt that fueled the era of easy money over the past few years. The risk of lending could be spread across many players. Now, spooked by several big hedge fund collapses and a widening crisis in the mortgage industry, these investors are saying no.

"The whole system is choked up," said a hedge fund manager, who spoke on the condition of anonymity because he did want to endanger deals he has in the works. "The buyers, like us, are saying -- 'Not a chance.' . . . We are getting calls today from banks that have this inventory they want to get rid of. They want to get rid of everything they can, even if they have to take a hit on it."

With hedge funds and other investors refusing to buy such debt, investment banks have to sell them at a severe discount to investors or hold on to them. Keeping the debt can be painful for investment banks because they would have to absorb the losses if the borrowers default. A large inventory of unsold loans also means less revenue for banks. Wall Street banks are currently holding $289 billion in unwanted debt, according to research firm Dealogic.

Alarmed bankers are pushing private-equity firms to scuttle deals or renegotiate prices, which most private-equity firms do not want to do. Such disputes are putting the relationship between these powerful players in jeopardy. Their partnership has been at the heart of the buyout boom and the source of enormous wealth for Wall Street.

No activity has been more profitable to investment banks than private-equity buyouts, which typically provide more than $1 billion in fees every year.

Wall Street insiders acknowledged that the buyout run is being tested. "The process is slowing down because everybody is more cautious," said Donald Marron, chairman and founder of private-equity firm Lightyear Capital. "Everybody wants to think about things a little more."