Wall Street Blocked By Buyout Debt

By David Cho
Washington Post Staff Writer
Thursday, January 31, 2008

Wall Street banks have failed to unload $220 billion of debt, which financed a wide range of major corporate buyouts initiated over the past two years, and that backlog is choking the credit markets despite recent efforts by the Federal Reserve and Treasury to invigorate the economy.

The troubles have ensnared such major acquisitions as Harrah's Casino Hotels, Alltel and Chrysler. Some deals could unravel if banks cannot find backers for the buyout loans they committed to funding. This could further shake investors' confidence in a financial system reeling from massive losses in home mortgages.

The institutional loan market, where buyout loans are priced and traded just like stocks on an exchange, has remained frozen far longer than top private-equity investors predicted. Last summer, some of these investors said it would take about six months for the credit markets to clear the logjam of buyout debt.

Instead, loans for deals as old as Clear Channel Communications, which was swung in 2006 for $18.7 billion, are still getting the cold shoulder from debt investors.

"Six months ago, we were saying it's going to take six months to work through this debt," said Christopher Donnelly, vice president of Standard & Poor's Leveraged Commentary & Data. "Well, what happened was none of this paper was sold . . . and now we think it's going to take much longer to clean this up."

Debt investors, which include hedge funds, specialized investment firms and big brokerages, have for years been major buyers of loans from Wall Street banks, freeing banks to lend even more money. This is a key reason lending surged in the past five years, leading to a boom in mortgages, car loans, credit cards and big private-equity deals.

But after absorbing massive losses from their portfolios of subprime mortgages, the investors have become unwilling or unable to buy loans of any kind.

"People woke up after they got spooked by subprime," said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship. "The mortgage markets got souped. That's why investors ran away from them, and many of these investors were the same ones who were holding leveraged loans."

Banks, including nearly all of the biggest names on Wall Street, are being forced to hold onto that debt. This has a chilling effect on their operations and hurts earnings, similar to the way large inventories of unsold clothes dampen profits at retail stores. A major source of income for banks is the fees they generate from making loans, repackaging them as securities and selling them to debt investors.

Now they face a difficult choice. They can either sell these loans at extreme discounts and take the losses or hold onto them and hope the appetite for buyout debt revives.

As of this week, the banks were struggling to sell $152 billion in buyout loans and $68 billion of buyout bonds, according to Donnelly. With such a massive amount in the pipeline, these financial firms have little money or desire to back new buyouts.

"You won't see any more gigantic deals for a while," Donnelly added.

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