Manor Care LBO a tall order for rattled lenders

By Jonathan Keehner and Al Yoon

NEW YORK (Reuters) - The leveraged buyout of top nursing home operator Manor Care Inc HCR.N faces a major hurdle as Wall Street dealers struggle to sell bonds in the $850 billion commercial mortgage bond market.

Underlying real estate helped justify Carlyle Group's CYL.UL July offer for Manor Care of $6.3 billion, a 20 percent premium over the company's stock price before announcing it was for sale in April. Now uncertainty about the properties has lenders balking at parts of the deal.

Commercial mortgage backed securities (CMBS), a key funding source that had launched real estate dealmaking to record heights in recent years, was expected to finance over $4 billion of the Manor Care transaction. But since the credit crunch, lenders have grown wary of buyout-related CMBS.

CMBS are bonds backed by income from loans on office buildings, retail stores, hotels and multifamily housing.

Issuance, running at a record pace through August, plunged 73 percent to $6.2 billion in October from year-ago levels, according to Credit Suisse data.

"Despite the fact that you haven't seen any delinquencies or defaults, that market right now is just not financing big deals," Morgan Stanley managing director Seth Weintrob said at The Deal's M&A Outlook 2008 conference in New York on Wednesday. "The debt spigot is basically shut off."

CMBS related to buyouts are often leveraged and costly relative to the market, according to lenders. The securities may also lack diversity since they are often concentrated on a single sector with unique risks.

"Right now, we're not too interested in CMBS from a buyout," said Larry Duggins, executive managing director of Centerline Capital Group, which buys CMBS. "We're not interested in the specialty deals until the CMBS market gets cranking."

Investors are particularly leery of nursing home financings because the operations can be high risk. That concern is likely magnified by sour market conditions, said Joseph Kelly, a managing director of Fitch Ratings' CMBS group in New York.

Regulatory scrutiny of deals increased last month after U.S. senators, citing a report that facilities bought by private equity companies have a shoddy safety record, asked firms including Carlyle about their management of nursing homes.

UNSETTLING INVESTORS

Loan investors say that while Manor Care has a good credit rating for a buyout, the reliance on $4.6 billion in CMBS debt has raised questions about the proposed structure of the entire deal, according to Reuters Loan Pricing Corp (RLPC).

The discount on Manor Care's $700 million term loan had to be adjusted to 96.25 cents on the dollar from 98 cents, according to RLPC, mainly due to uncertainty surrounding the CMBS portion of the transaction.

The company has raised around $1 billion of the $1.6 billion mezzanine portion of the CMBS offering that is riskier than the senior class, according to RLPC.

But the remaining $600 million mezzanine piece is priced higher, according to a source familiar with the offering, and bankers may struggle to sell it without increasing the yield.