Friday, May 4, 2007

Fast, Loose Credit Scares Even the Buyout Gurus

Mark Gilbert

By Mark Gilbert

May 3 (Bloomberg) -- Central bankers aren't the only people distressed by lax lending standards. Even the dealmakers who depend on cheap finance with few strings attached are complaining that finance is too cheap and there aren't enough strings.

``There's too much liquidity in the system,'' Philip Yea, chief executive officer of 3i Group Plc, Europe's largest publicly traded venture-capital and buyout firm, said last month. ``There's too much debt available.''

Too much debt available? That's tantamount to Kate Moss complaining that her photo is in too many magazines, Steve Jobs moaning about iPod ubiquity or Madonna criticizing African nations for not having more stringent child-adoption policies.

So what's going on here? Why, in the fastest, loosest credit markets seen since a tulip bulb was worth as much as a house, are the supposed beneficiaries of loan largess bleating about easy money and the boom in global liquidity from Texas to Tokyo?

Is it because cut-price loans are propping open the mergers- and-acquisitions door for interlopers? Are existing leveraged- buyout specialists concerned about new entrants pushing up prices, and exacerbating the risk that a big deal will sour and attract the unwelcome attention of regulators?

Steve Rattner, co-founder of buyout firm Quadrangle Group LLC, told Bloomberg reporter Edward Evans in January that ``the world isn't pricing risk appropriately. Investors are simply not being paid for the risks they're taking.''

Ninja Loans

You might have expected renewed caution among lenders after the willingness of some U.S. mortgage companies to grant so- called Ninja loans -- No Income, No Job or Assets -- triggered the collapse of the U.S. subprime mortgage market and helped sink an armada of companies.

Larry Fink, CEO of BlackRock Inc., says the subprime debacle has had a domino effect on the rest of the credit market -- just not the one you might have expected.

``We're seeing fewer investments in subprime, but that money needs to be put to work so they're going into other credit markets,'' Fink said in an interview published by the Financial Times newspaper last week. ``Historically, when we've seen one problem, we've seen an adjustment throughout the marketplace. We've seen no indication of that yet. We've seen the actual opposite.''

While liquidity is notoriously hard to define, the Bank of England took a stab at quantifying it last month in its Financial Stability Report. The central bank combined some key market measures -- the gaps between bid and offer prices on bonds, currencies and stocks, the ratio of market returns to trading volumes, and spreads in the credit market -- to produce an index showing that financial-market liquidity is at its highest level since at least 1992, and has doubled in the past four years.

Loaded With Debt

``Markets are currently very liquid and have been so over the past few years,'' the central bank wrote in the report. ``Maximum debt levels for European LBOs are now consistently above seven or eight times earnings, whereas the maximum was around six times earnings a year ago.''

While that extra leverage makes deals more risky, it isn't deterring newcomers from getting in on the action. ``There's a lot of money in the Middle East that the private-equity companies can now access,'' said Colin McKay, the New York-based head of PricewaterhouseCoopers LLP's private-equity division in March. ``The force that hasn't even entered yet into the private-equity market to any degree is the trade surplus in China and where that's going to be invested.''

`Capital Everywhere'

Investment banks used to be content to take a fee for advising on takeovers; now they can demand equity participation, boosting the pool of capital available to get deals done.

``There's capital everywhere,'' buyout doyen Henry Kravis of Kohlberg, Kravis, Roberts & Co. said at a New York conference last week. ``It's very smart of these firms to be in it. I just wish they wouldn't compete with us, but they do.''

In the U.S., the California Public Employees' Retirement System, the nation's biggest public pension fund, is allocating more money to private-equity firms. In Canada, the Canada Pension Plan Investment Board, the Public Sector Pension Investment Board and the Ontario Teachers Pension Plan have all said they might bid for BCE Inc., the country's biggest telephone services provider. In the U.K., the Wellcome Trust Ltd. charity is part of a group trying to buy drugstore company Alliance Boots Plc.

As more buyers enter the fray, prices for doing deals rise, eroding the internal rate of return on transactions. In a low- yield environment, however, even a slowing bandwagon can be an attractive investment vehicle for latecomers.

Settling for Less

``Inevitably, returns can't be as good as they've been,'' David Rubenstein, co-founder of Carlyle Group, said last week. ``The returns that people will be able to get are better than anything else they can do with their money, at least that's legal.''

The biggest worry that the LBO community has, though, is that an overpriced, overleveraged deal will collapse. ``Some of these deals will go bad,'' Quadrangle's Rattner said in January.

When you borrowed from a bank, there was room to negotiate a rescue when the business plan melted. When your lender is a hedge fund trying to deliver monthly returns, the ear may not be anywhere near as sympathetic.

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Mark Gilbert in London at

Last Updated: May 2, 2007 19:16 EDT

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