Posted on 06/20/2007 6:05:11 AM PDT by OpusatFR
NEW YORK (Reuters) - Investors looking for signs of a crack in the credit markets are turning their attention to a corner of the debt market that's been feeding the leveraged buyout frenzy.
Banks used to finance buyouts mainly with loans on their balance sheets, but are now packaging and selling that debt to investors using instruments called "collateralized loan obligations" (CLOs) that group various loans together to diversify risk.
For example, debt issued by the $5.6 billion private-equity purchase of rental company Hertz (HTZ.N: Quote, Profile, Research) is now in the hands of more than 200 CLOs. Similarly, HCA Inc's debt from the buyout of the hospital chain for $21 billion went to 58 CLOs, according to Morgan Stanley (MS.N: Quote, Profile, Research).
But investors are becoming concerned that a deterioration in credit quality, or the recent rise in U.S. Treasury yields, might force a re-evaluation of some portfolios causing defaults such as occurred in the subprime mortgage sector in the U.S. in the past year.
In the old days of relationship banking, banks relied on credit quality control and huge balance sheets to ride out any problems, but CLO investors may be more short-term oriented.
Lack of credit quality control by some managers of CLOs is particularly frightening to veteran private equity investors.
"What all of this will show -- and it will show more as CLOs become more popular -- is that risk management has not been very well practiced," said billionaire financier Wilbur Ross, founder of private equity firm WL Ross & Co. "That's going to hurt a lot of people, and will ultimately explode the bubble."
Ross cited an example of a fund manager who bought a $20 million chunk of debt from one his portfolio companies but did not bother to show up to a due diligence meeting. The fund manager did not think the chunk was big enough to worry about, Ross said.
At the very least, there are concerns that the credit tap may get turned off, if weaker hands fold and CLO values drop. Continued...
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