Friday, April 4, 2008

Offloading the crap assets (or are they crap?)

April 3 (Bloomberg) -- Lehman Brothers Holdings Inc., seeking to get high-risk, high-yield loans off its books, created a $2.8 billion collateralized loan obligation.

Freedom CLO contains 66 loans, including debt the fourth- largest U.S. securities firm underwrote for buyouts, according to the indenture filed last week. New York-based Lehman will hold a piece of the $565 million subordinated note, the riskiest portion, according to the term sheet. The bank sold $2.2 billion of bonds with investment-grade ratings.

Lehman joins Deutsche Bank AG and Credit Suisse Group in creating CLOs to reduce loans on their books without selling them in the open market. Banks have $200 billion of buyout debt they can't easily sell after the price of leveraged loans tumbled to 88.8 cents on the dollar from 100 cents on the dollar last June, according to Standard & Poor's.

``Banks are focused on managing their exposure,'' said J. Paul Forrester, the Chicago-based head of the collateralized debt obligation practice at law firm Mayer Brown LLP. ``Balance sheet CLOs allow them to reduce the risk to the size of the subordinated tranche they are holding.''

A Lehman spokesman in New York, Randall Whitestone, declined to comment.

Deutsche Bank created two balance sheet CLOs, both named Genesis, in September and November, according to Bloomberg data. Credit Suisse formed the $1.7 billion Integral Funding in September.

First Data, TXU

Freedom contains loans to buyouts including KKR's First Data Corp., the Greenwood Village, Colorado-based payment processor, and power producer TXU Corp. of Dallas, purchased by KKR and TPG Inc. TXU was renamed Energy Future Holdings Corp.

The portfolio also has loans that couldn't be sold to investors, including Sequa Corp., purchased in December by the Carlyle Group, and bank lines for companies such as Countrywide Financial Corp., the largest U.S. mortgage lender, and Imperial Tobacco Group Plc, the maker of Davidoff and West cigarettes, according to the prospectus.

Loans for First Data trade below 90 cents on the dollar. The Countrywide five-year revolving bank line is priced at 79.5 cents on the dollar, according to the prospectus.

Freedom CLO sold the bonds in a private placement. The $2.2 billion in notes will pay interest of 2.25 percentage points above the three-month London interbank offered rate. That debt is rated A2 by Moody's Investors Service, the sixth level of investment grade, and an equivalent A from Standard & Poor's.

Private Equity

The unrated subordinated note pays interest generated by investments in the loans after the rated debt has been repaid. The loans pay an average coupon of 3.5 percentage points above three-month Libor, currently 2.73 percent.

Blackstone Group, Apollo Management LP and Kohlberg, Kravis Roberts & Co., all based in New York, were among the private equity firms that negotiated more than $370 billion in financing to back acquisitions before losses on subprime-related mortgage securities spread to loans, bonds and CDOs.

CDOs, which have helped fuel $232 billion in bank writedowns since the beginning of 2007, repackage assets into new securities with varying risks. CLOs, a type of CDO, repackage buyout loans into new securities.

CLOs bought 60 percent of buyout loans before credit markets froze last year, said Mark Shafir, the global co-head of mergers and acquisitions at Lehman, in an interview last week on Bloomberg Television.

Debt Backlog

Unable to sell primarily to CLOs, banks have reduced the buyout debt backlog by selling loans at discounts to face value to hedge funds and private-equity firms. Several transactions have also failed, such as J.C. Flowers & Co.'s $25.3 billion acquisition of SLM Corp., also known as Sallie Mae. An acquisition of San Antonio-based Clear Channel Communications Inc. may be canceled over a dispute about bank financing.

This year, banks have sold $28.5 billion of CDOs backed by high-yield, high-risk loans, versus $62 billion for the first quarter of last year, according to JPMorgan Chase & Co. data. Lehman's CLO accounted for 40 percent of total March volume, according to an April 2 report from Wachovia Corp. analysts led by Brian McManus.

Lehman reduced its LBO backlog by $6.1 billion to $17.8 billion since the beginning of the year, Chief Financial Officer Erin Callan said on a conference call with investors on March 18. The bank booked losses of $500 million on leveraged loans during the quarter, she said.

Lehman this week sold $4 billion of convertible preferred shares to shore up capital depleted by the U.S. housing slump.

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