NEW YORK 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.
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.
The remaining portion is expected to be pitched to investors next week, but the timing on the additional $3 billion CMBS offering is unclear, which is atypical at this point in syndicating buyout financings, according to RLPC.
Banks including JPMorgan Chase & Co (JPM.N), Bank of America Corp (BAC.N) and Credit Suisse Group CSGN.VX are committed to financing over $5 billion in debt for the Manor Care deal, according to filings. With the company trading just below Carlyle's offering price of $67 per share, the market is confident the deal will close.
On Wednesday, Carlyle co-founder David Rubenstein told Reuters: "There are a couple of regulatory approvals that are in the process of being obtained. The deal will close in the near future, in my view."
On Thursday, Manor Care said it expects the deal to close "in the near term," adding: "There can be no assurance that the closing will in fact occur within the expected time frame."
Shares of Manor Care closed down 35 cents to $66.41 on the New York Stock Exchange following Thursday's announcement
Lending commitments have recently fallen apart in some buyouts.
Mortgage and vehicle fleet company PHH Corp (PHH.N) said in September that its $1.8 billion buyout could be scuttled by a shortfall of up to $750 million in debt financing that JPMorgan and Lehman Brothers Holdings Inc LEH.N were to arrange.
If debt financing falls through, Manor Care's recourse against Carlyle would be limited to a $175 million termination fee, according to filings. A spokesman for lead manager JPMorgan declined to comment on Manor Care.
Costs of the Manor Care deal may have already taken a toll on the banks. In September, Credit Suisse said it was firing 150 people in its mortgage-backed securities business.
One source suggested that the layoffs came as the CMBS market has weakened.
"Credit Suisse, which did a lot of financing in health care and nursing, has fired most of their health-care CMBS team," said a source familiar with the Manor Care offering. "This may have been the straw that broke the camel's back."
A spokesman for Credit Suisse declined to comment.
Difficulty in financing the deal could be a bad sign for other large buyouts that may look to tap CMBS markets, such as gaming company Penn National Inc (PENN.O), which agreed in June to be bought by a group that includes Fortress Investment Group
(Additional reporting by Michael Flaherty and Faris Khan; Editing by Jeffrey Benkoe)