Leftover LBO debt points to broken deals, defaults

NEW YORK (Reuters) - The fallout from a two-year binge of using borrowed money to finance corporate acquisitions is set to intensify due to a $120 billion pile of high-risk debt still needing a home.

Those high-yield loans and bonds make up about a third of the $340 billion mountain of debt that existed last year. The remaining debt is mostly sitting on bank balance sheets as a result of funding commitments made during the era of aggressive financing of leveraged buyouts before the global credit crunch began last year.

Debt that still needs to be sold by banks for companies including BCE Inc (BCE.TO), known as Bell Canada, and U.S. chemical maker Huntsman Corp (HUN.N), may embroil banks, companies, and private equity firms in a high-stakes fight over the financing of past deals.

Shareholders may have to accept a lower acquisition price, private equity firms may have to accept more liberal terms on outstanding loans, or banks have to accept a lower price or get stuck with problem loans.

"The initial response from all sides is 'we're not budging,'" said Martin Fridson, chief investment officer at Fridson Investment Advisors in New York, where he oversees a high-yield debt portfolio.

"Now, the general environment is the music has stopped, and everyone is stuck, so everyone's trying to lay off the problem on someone else," he said.

With the U.S. economy struggling and demand weak for risky debt, the outcome is likely to be a rise in abandoned LBO deals, higher borrowing costs, or more corporate defaults and bankruptcies.

The price of the bonds of Huntsman Corp, for example, plunged on Thursday after private equity firm Apollo Management attempted to back out of a planned $6.5 billion takeover of the Texas company by Apollo's Hexion Specialty Chemicals.

In the most extreme cases, such as Hilton Hotels Corp, the leverage involved was nearly 10 times the company's earnings. Hilton went private last year after a $20 billion buyout by private equity firm Blackstone Group LP (BX.N).

JPMorgan Chase & Co estimates that about 80 percent of the backlog of LBO debt is "extremely aggressive" with an average total leverage at 7.7 times earnings for the seven largest pending LBOs.

At the peak last September, more than $340 billion in LBO debt needed to be sold. Since the credit market crash last year, firms have whittled away that debt to about $82 billion of loans, according to Reuters Loan Pricing Corp data, and about $40 billion in high yield bonds.

"The debt overhang is shrinking but the risk is rising in terms of what the market will accept," said Kingman Penniman, president of KDP Investment Advisors, a high-yield research firm. Companies likely will need to offer double-digit yields to attract buyers, he said, at a time when credit conditions are still tough.

"Resolving the credit crisis has not resolved the credit crunch," Penniman said. "The wider ramification here is will financial institutions make capital available to good companies to help companies keep running and stay in business?"

In some cases, deals could fall apart. Huntsman affiliate Huntsman International's 2015 notes fell to 89 cents on the dollar, down 14.25 cents, according KDP data, on Apollo's attempt to back out of its merger agreement.

On Wednesday, Apollo's Hexion filed a lawsuit against Huntsman that would seek to limit its liability if the deal fails. Huntsman has said it will fight Apollo's move to scuttle the buyout.

"While both Hexion and Huntsman can be successful as separate companies, they cannot now support the debt load that was agreed to at the time the transaction was put together," Hexion's Chief Executive Craig Morrison said in a statement.

Apollo said bank financing for the deal, one of the last to close from the private equity buyout boom that ended in the middle of 2007, was in jeopardy because of Huntsman's weakened financial position.

Bell Canada bondholders are trying to block the world's largest leveraged buyout. A case before the Supreme Court of Canada this week may decide the fate of the $34.1 billion takeover of BCE. The court delayed a ruling on Tuesday.

For other debt deals, such as Clear Channel Communications (CCU.N), companies and financial firms may have to pay a premium to get the debt off their balance sheets, as credit conditions still remain tight. Clear Channel is trying to close a third of its $10.7 billion term loan at a discount to lure investors.

(Additional reporting by Dena Aubin, Euan Rocha and Megan Davies)