DEALTALK-New debt funds get off to a tough start

By Michael Flaherty

NEW YORK, Oct 16 (Reuters) - Vulture funds aiming to sink their claws into unwanted leveraged buyout debt are having a hard time getting off the ground.

The funds being raised by private equity firms and hedge funds to take advantage of the credit squeeze are not finding the bargain prices they hoped for.

Instead, loans are selling for around 96 cents on the dollar -- hardly the 90-cent-or-below fire sale prices the funds are banking on.

While there is still more than $300 billion of leveraged buyout (LBO) debt hung up on Wall Street, credit markets are holding up fairly well. Banks have taken heavy write-downs but the damage has not been as bad as some analysts predicted.

So with the credit markets chugging along, some are questioning the wisdom behind the LBO debt funds that firms such as Citigroup Inc (C.N), Goldman Sachs (GS.N), Kohlberg Kravis Roberts & Co [KKR.UL] and TPG Capital [TPG.UL] reportedly are pursuing.

"I personally believe that too much money is being raised to do this," said Scott Malpass, vice president and chief investment officer at the University of Notre Dame.

"And now that the volatility has gone away, and spreads have started to tighten again, banks will want to be more patient and tougher at what they want to sell the loans at," said Malpass, who invests part of the school's $5.7 billion endowment into private equity firms.

Private equity firms buy companies by borrowing most of the money. Frothy credit markets allowed buyout firms to do more than $1 trillion of deals in the last two years.

Food chain Dunkin' Donuts, broadcaster Univision, hospital group HCA and Hilton Hotels Corp HLT.N -- whose deal is expected to close this month -- all agreed to be bought by private equity firms.

The credit crunch this summer cut off borrowing from banks and spooked debt investors, leaving banks stuck with more than $300 billion of loans on their balance sheets, the so-called hung debt.

That scenario prompted the new crop of vulture funds.

DISCUSSIONS

Citigroup and KKR are in discussions about a type of fund that would invest in banks' hung debt, according to sources familiar with the matter. Citi and KKR declined to comment about the arrangement.

Citigroup may allow KKR to borrow as much as $8 billion for the fund, with KKR providing $2 billion through its Strategic Capital Fund, Financial News reported on Wednesday.

The Citi-KKR arrangement has stunned some on Wall Street.