LBO debt logjam threatens further write-downs for banks

By Walden Siew and Megan Davies

NEW YORK (Reuters) - Leveraged loan problems are threatening Wall Street banks with a fresh round of write-downs from a $205 billion backlog of buyout debt.

The unsold debt piled up during the leveraged buyout (LBO) boom remains a key concern for banks, already hit by subprime mortgage woes which surfaced in July, investors and analysts fear. If that results in further write-downs, Wall Street could suffer deeper pain which could bring further gloom to the wider economy.

The subprime mortgage meltdown last summer caused banks to reel in lending, halting the two-year private equity deal spree. Banks got stuck with huge loan portfolios on their balance sheets that they could not sell to investors.

Worries about these hung loans have not gone away.

"The concern remains that LBO debt could come back to bite the institutions that made these commitments," said David Honold, portfolio manager and financial services analyst at Turner Investment Partners in Pennsylvania.

"To the extent that banks have been unable to sell debt for previously completed transactions, there is a concern for further negative earnings impact," Honold added.

Banks typically sell on to investors debt they assume to facilitate deals, but that's been a challenge since the subprime mortgage crisis triggered a wholesale flight from risky assets last July.

That means the debt of a number of deals that have closed, from the acquisition of automaker Chrysler to newspaper publisher Tribune Co., are still sitting on banks' balance sheets.

Now some analysts fear that a worsening economy may cause some companies taken private to default on their debt, causing banks to further write down the value of their portfolios or even unload other debt at fire-sale prices.

"It's obvious the banks are not going to be able to get rid of this debt easily," said Marilyn Cohen, president and portfolio manager at Envision Capital Management in Los Angeles, where she oversees $225 million in assets. "Deals are starting to fall through, and this is going to continue to put pressure on the banks that are holding the debt.

"We're going to see some hits, and banks will be taking more losses on this," she added.

That could mean more trouble for the credit and equity markets, which have been in turmoil since July when the subprime loan crisis hit.

"For the wider economy, growth is slowing down with or without the leveraged loans being sold. If the loans are stuck, it portends poorly for any easing of the credit crunch," Cohen said.

STUCK ON BANKS' BALANCE SHEETS

Banks are trying to sell institutional investors such as hedge funds about $155 billion in unsold loan debt, according to Reuters

LPC.

This includes about $50 billion of loans that banks failed to sell last year during the height of the subprime crisis. In addition, banks are also looking to sell nearly $50 billion in high yield bonds, according to KDP Investment advisors. Most of this loan and bond debt will be used to finance buyouts that have already been struck.

Banks with exposure to unsold institutional loans include Citigroup (C.N), Deutsche Bank (DBKGn.DE), Goldman Sachs (GS.N), Credit Suisse (CSGN.VX), Lehman Brothers LEH.N, Morgan Stanley (MS.N), Banc of America (BAC.N) and JP Morgan (JPM.N), according to Reuters LPC.

Many of those banks have been grappling with exposure to another troubled debt market, that of collateralized debt obligations and similar assets which have been hammered by subprime related fears. In the second half of 2007, major banks announced more than $50 billion of write-downs and losses.

The total amount of private equity debt stuck on banks' balance sheets as of late summer was around $350 billion -- a figure that included debt underwriting other than leveraged loans. That figure has been whittled down to around $200 billion, bankers say, with the closing of a few large LBOs and the cancellation of others.

So while around 40 percent of the debt backlog has been worked through, there is still a long way to go.

Investment banks and other institutional investors have to value those backlogged loans at their market price for accounting purposes, or mark-to-market. So further declines in their value could mean further write-downs for the banks.

One tough deal for banks to syndicate stems from Cerberus's $7.4 billion acquisition of automaker Chrysler LLC from Daimler AG (DAIGn.DE). The deal's underwriters in November postponed a $4 billion loan sale for the buyout in face of weak credit market conditions and worsening news from the autos sector.

However, it is hard to measure banks' individual exposure to leveraged buyout debt.

"Banks don't usually tell how many hung loans they have on their portfolios. You can't calculate it but you can make the gross assumption that trouble with write-offs will continue going forward," said Richard Bove, a veteran banking and brokerage analyst at Punk Ziegel & Co.

In addition to buyouts which have closed, there are still a number of deals yet to close, like buyouts of Myers Industries Inc (MYE.N) and Clear Channel Communications (CCU.N), that have to work their way through the financing market.

"It ain't too good," said Greg Habeeb, referring to the backlog of debt. Habeeb, a portfolio manager at Calvert Asset Management in Bethesda, Maryland, oversees $8.4 billion in assets. "The market is fragile and it's waiting for further news. The market is building in very pessimistic scenarios."

(Additional reporting by Faris Khan, Jonathan Keehner and Michael Flaherty in New York)

(Editing by Phil Berlowitz)