Hedge debt buying may spur LBO market

By Dane Hamilton

NEW YORK (Reuters) - Restarting a leveraged buyout machine hobbled by the subprime mortgage collapse will take many months, but hedge funds are gearing up to inject liquidity that could spur the market, executives told the Reuters Hedge Funds and Private Equity Summit this week.

The new buyers' market for debt is likely to be dominated by established hedge and buyout firms that thrive in times of distress, including Cerberus Capital Management LP CBS.UL, Avenue Capital, Apollo Management, Oaktree Capital Partners and other multibillion dollar firms, experts said.

"A lot of the best names in distressed debt have already raised their money and the financial services area is getting a lot of attention," said Stephen Moseley, president of StepStone Group LLC, a private equity advisory firm founded by senior executives at consultants Pacific Corporate Group.

News that Citigroup Inc (C.N) is preparing to sell some $12 billion in loans to a group of private equity buyers including TPG Capital LP TPG.UL, Apollo and Blackstone Group LP (BX.N) could be the beginning of this trend, the experts said.

"Unless they free up capital, they are not going to be in the (loan) origination business for some time," said Josh Steiner, managing director and co-founder of Quadrangle Group. He said his media and telecom-focused buyout firm bought "a lot of distressed debt" in companies including Adelphia, Charter Communications and other names in 2002 and is considering wading into that market again.

Fueled by cheap money and ready buyers of syndicated debt, the leveraged buyout market boomed until last summer, when the subprime mortgage collapse froze debt markets. That left banks that arranged deal financing unable to sell tens of billions of dollars in LBO debt, or "leveraged loans," stalling their ability to arrange new deals.

Now after billions of dollars in write-downs on declining values for their unsold inventory of loans, banks are beginning to slash the prices -- sometimes more than 10 percent off face values. This is prompting buyers, particularly hedge funds, to start looking anew at the debt.

But some experts told the Reuters summit it will take more than just clearing out a backlog of debt to start banks' lucrative buyout machinery again.

They will also have to fix the failed risk controls that led to the creation of toxic CDOs, CLOs and other structured debt securities whose values plummeted when mortgages began defaulting, ultimately causing the collapse of investment bank Bear Stearns Cos Inc BSC.N.

"Just because the banks sell down their leveraged loans doesn't mean they all of a sudden become lenders again," said Bruce Richards, chief executive of the $11.5 billion Marathon Asset Management, an active buyer of distressed debt in all forms. "You have to fix the machine and get the business restarted."

Lawrence Schloss, founder of Diamond Castle Holdings, a $2 billion buyout fund that relies on debt to finance deals, said he expects the market to recover, but slowly.

"They'll move the LBO debt out, but that doesn't mean it will turn around the way it was," said Schloss, calling the financing system "constipated."

"You'll turn it on in smaller units," he said.

Still, one investment banker is optimistic the debt markets will recover enough in coming months for the banks to start underwriting significant buyout deals.

"I feel pretty good we will see capital underwriting by Labor Day," said Mark Epley, head of the financial sponsors group at Deutsche Bank (DBKGn.DE), which helps arrange buyout deals.

(Editing by Jeffrey Benkoe)