KKR, Blackstone Push for Record Low LBO Loan Rates (Update1)
By Harris Rubinroit
Feb. 21 (Bloomberg) -- Henry Kravis and Stephen Schwarzman never had an easier time getting the lowest interest rates on loans from their bankers.
Just three months after borrowing $12.8 billion to pay for hospital operator HCA Inc. in November, Kohlberg Kravis Roberts & Co. and its partners negotiated a new loan with lower rates. Schwarzman, chief executive officer of Blackstone Group LP, is doing the same for a $3.5 billion loan that financed the takeover of Freescale Semiconductor Inc., the mobile-phone-chip maker.
Leveraged buyout firms are leading borrowers refinancing $64 billion of loans so far this year, more than in all of 2006, according to ratings company Standard & Poor's. Banks are giving in and reducing rates because corporate defaults are near all- time lows.
``This is the best loan market for borrowers I have ever seen,'' said Kenneth Moore, a managing director at First Reserve Corp., a private equity firm in Greenwich, Connecticut, that manages more than $12.5 billion and specializes in buying energy companies.
Loans for companies rated four or five levels below investment grade yielded an average 2.26 percentage points more than the three-month London interbank offered rate in the week ending Feb. 15, S&P says. That gap over Libor, a lending benchmark, was the smallest ever and compared with more than 4 percentage points in 2003. The difference saves $17.4 million a year for every $1 billion a company borrows.
HCA Refinances
Nashville, Tennessee-based HCA this month refinanced $12.8 billion of term loans arranged when a group including New York- based KKR, led by the 63-year-old Kravis, agreed to buy the company for $33 billion.
The new loans pay interest at 2.25 percentage points over Libor, compared with the original agreement of 2.50 percentage points and 2.75 percentage points. For KKR and its partners, the annual savings amount to $54 million. The three-month Libor is 5.36 percent.
Loans helped fuel a record $1.55 trillion in mergers and acquisitions in the U.S. last year, New York-based S&P said. So- called leveraged loans financed 57 percent of those transactions, the highest in seven years, it said. Leveraged loans are considered below investment grade and are rated below BBB- at S&P and Baa3 by Moody's Investors Service.
``There is clearly room to exceed the biggest loan deal ever done,'' Moore said. HCA's financing was the largest sold to investors.
Charlotte, North Carolina-based Bank of America Corp., along with JPMorgan Chase & Co. and Citigroup Inc., both based in New York, led banks in arranging $480 billion of leveraged loans last year, up 62 percent from 2005, according to S&P. Parts of the loans are sold to investors, two-thirds of which aren't banks, up from 25 percent in 2001, according to S&P.
Investor `Influx'
More than 250 institutions purchased high-yield loans last year, compared with fewer than 100 in 2002, S&P says. Many of the investors are new to the market, including Boston-based State Street Global Advisors, which said in November it would start buying loans.
``The influx of additional market participants has diminished the ability for investors to organize and oppose a re- pricing,'' said Frederick Haddad, a partner at New York-based GoldenTree Asset Management LP, which oversees about $7.9 billion. ``The re-pricings are a function of too much liquidity. Private equity firms looking to get better terms and one-up each other have become epidemic in the loan market.''
Private equity firms announced more than $400 billion of acquisitions in the U.S. last year, including nine of the 10 biggest LBOs, according to data compiled by Bloomberg. Private equity firms typically finance about two-thirds of the purchase price with debt, resulting in below-investment grade credit ratings for the target company.
Little Risk
Schwarzman, 60, surpassed the record this month when New York-based Blackstone paid $39 billion for real estate investment trust Equity Office Properties Trust of Chicago.
Lenders see little risk in giving borrowers what they want. An expanding economy is making it easier than ever for companies to meet their debt payments. The default rate on leveraged loans was 0.45 percent in January, the lowest ever, according to S&P. That compares with an average of 3.05 percent over the past 10 years, according to data compiled by Credit Suisse Group.
The U.S. economy will expand 2.7 percent this year, according to a survey of 69 analysts by Bloomberg News from Feb. 1 to Feb. 8. The anticipated rate of growth is 0.2 percentage point faster than a survey the previous month.
Lenders are recouping most of their money even after defaults. Recovery rates for bank debt averaged an all-time high of 93 percent last year, an S&P study found.
Loan investors in New York-based Refco Inc., the futures trader that in October 2005 filed for bankruptcy, recovered all their principal last year, according to S&P. Bondholders received about 83 cents on the dollar.
Disappearing Gap
Money is pouring into loans from investors looking to profit after the gap between interest on loans and yields on speculative-grade bonds, which offer fewer protections, disappeared following the Federal Reserve's 17 rate increases between June 2004 and June 2006.
Borrowers with non-investment-grade ratings pay interest of 7.58 percent on average for loans, compared with about 7.59 percent for high-yield bonds, according to New York-based Lehman Brothers Holdings Inc. Over the past 10 years, loan rates have averaged 2.30 percentage points less than yields on junk bonds, which have fewer protections.
``High-yield bond investors are moving into the loan market as the spreads between high-yield bonds and leverage loans have narrowed,'' said Seth Katzenstein, a New York-based managing director at GSC Group, which manages more than $18 billion.
Market Lull
Lenders will be able to reject demands for lower rates in coming months because more companies will require credit, said Howard Tiffen, who oversees $7 billion of bank debt at Morgan Stanley Investment Management in Oakbrook Terrace, Illinois. Borrowers have profited from a lull in new deals, he said.
That will change in coming weeks because New Orleans-based Freeport-McMoRan Copper & Gold Inc. will need $11.5 billion of loans for its $26 billion acquisition of Phelps Dodge Corp., the world's third-largest copper producer and based in Phoenix, Arizona.
A group led by Kinder Morgan Inc. Chairman Richard Kinder said in August that it would take the Houston-based company private for about $22 billion, using $8.6 billion of loans for the purchase, according to filings with the U.S. Securities and Exchange Commission.
``The big deals coming will bring the market back into equilibrium,'' said Tiffen, who has run the Van Kampen loan funds since 1999. ``The market is not well-balanced. But, this is not particularly unusual. Most years we see periods where demand gets ahead of supply and vice versa.''
Too Complacent
Banks may be too complacent, according to CreditSights Inc., a New York-based debt research firm.
``The worst of loans are written in the best of times and that could well apply to the current lending boom,'' said Louise Purtle, an analyst at CreditSights. ``Loan sizes are increasing, borrowers are becoming more levered, and the number and stringency of covenants is being reduced.''
Borrowers in the U.S. this year have received or are seeking $16.3 billion of loans without so-called maintenance covenants, or restrictions such as quarterly limits on the amount of debt a borrower can have relative to earnings before items such as depreciation, interest and taxes. The amount compares with the record $24 billion for all of 2006, according to S&P.
`All About Control'
``Covenants are all about control,'' said GSC's Katzenstein. ``With covenants, you can get concessions from the borrower such as an increased interest rate or fees'' if they violate the terms of their loans, he said.
Austin, Texas-based Freescale is asking lenders to lower the rate on a $3.5 billion loan used to help fund its $17.6 billion LBO by a Blackstone-led group in December. The company in November agreed to pay lenders 2 percentage points above Libor. It wants to cut the margin to 1.75 percentage points, saving about $8.75 million in annual interest.
Nielsen Co., the owner of the ratings service and Adweek magazine, last month persuaded lenders to cut the margins on $5.2 billion of loans taken out in August that funded its $11.7 billion buyout. The group includes KKR, Blackstone and Carlyle Group of Washington.
Haarlem, Netherlands-based Nielsen is paying interest at Libor plus 2.25 percentage points, down from 2.50 percentage points to 2.75 percentage points on separate loans, slashing its annual costs by about $23.5 million.
To contact the reporter on this story: Harris Rubinroit in New York at hrubinroit@bloomberg.net .
Last Updated: February 21, 2007 10:30 EST
