Hedge Funds Expand in Primary Lending Amid Credit Tightening

Date: Thursday, September 6, 2007
Author: AP

NEW YORK (AP) - Hedge funds are increasingly positioning themselves as direct lenders to companies that are having trouble borrowing money from banks or through the bond market.

These investors aren't strangers to the world of lending, and they're preparing to play a bigger role by capitalizing on the wave of risk aversion that has swept global markets this summer. Banks are shying away from lending to riskier corporate clients and struggling to find buyers for hundreds of billions of dollars in debt stemming from the leveraged-buyout boom, opening the door for hedge funds and some private equity firms to fill the void.

Among the debt such firms hope to add to their books are the leveraged-buyout, or LBO, loans that traditional buyers are shunning. Some hedge funds, such as Oaktree Capital Management, are looking to purchase so-called hung bridge loans from banks. And other funds are working with private equity firms to directly finance planned corporate buyouts or are extending credit to struggling companies.

"Hedge funds have really grown up," said John Wilson, a partner with law firm Foley & Lardner, who has a client that's asking hedge funds to finance a planned LBO after bank funding dried up. "They're out there in all facets and circumstances, and here they're becoming an alternative lender."

It's a far cry from the days when hedge funds and other asset managers were strictly traders of highly liquid assets, such as stocks and bonds. Primary loans are harder to sell, because they require large buyers. But deep-pocketed hedge funds sense an opportunity to grab assets at low prices, and they hope to be able to sell the loans at a profit when investors' risk appetites recover.

One area these investors see as especially fertile is LBO debt that investment banks are eager to keep off their balance sheets. The sticking point is price, and it's unclear whether the banks will agree to sell low enough for these bargain-hunting buyers.

Investment banks have committed to place about $300 billion in loans and bonds before the credit crunch hit this summer. Normally, the banks would sell slices of the loans to other banks, insurance companies, structures called collateralized loan obligations, and hedge funds. But many would-be buyers are suddenly balking.

Some hedge funds, meanwhile, are raising cash from institutional investors and reallocating capital within their existing portfolios so they can afford to buy billions of dollars of the debt, according to people in the industry. Among those said to be gearing up to buy these loans are Fortress Investment Group, Angelo Gordon & Co. and Citadel Group. The funds didn't respond to requests for comment. Some funds are said to be teaming up with rivals to gain leverage in pressuring banks to accept their offers.

Oaktree is raising between $3 billion and $5 billion to buy banks' so-called hung LBO bridge loans, according to a person familiar with the matter. Banks issued bridge loans as placeholders to fund LBOs until bond-market financing became available. But with bond investors balking, the loans are looking like longer-term investments. Oaktree, which runs a private equity business and several hedge funds, plans to hold the loans or resell them if the price is right, this person said.

"There's plenty of parties that want to invest and help the banks out of their problems at the right price," said Steven N. Costabile, head of private equity at AIG Global Investment Group, the asset-management arm of insurance giant American International Group Inc., which is looking to invest in such funds.

Negotiations between investment firms and Wall Street banks are deadlocked over prices, say people in the industry. An official at a major bank said there recently was a gap of 5 cents on the dollar between what buyers were offering and what sellers would accept. At that price, the bank would prefer to stash the debt on its balance sheet until market conditions improve.

"The banks at this point are loathe to sell directly at a discount, because that's admitting defeat," said Robert J. Graves, a banking lawyer at law firm Jones Day. The first time a bank sells the debt at a low price, "that sets a very dangerous precedent for them, and you then have difficulty ever selling at par again."

That wall, however, may already have been breached. In July, banks sold $6 billion in loans financing Chrysler Financial's buyout at a discounted rate of about 95 cents on the dollar. First Data Corp.'s LBO loans probably will have to sell at a discount as well, possibly setting a precedent for future sales, market participants say.

Other hedge funds are being called upon to directly finance buyouts that are still in the negotiation phase. With private-equity firms having trouble finding banks to fully finance small and mid-sized deals, the buyout shops are grudgingly turning to hedge funds instead. Private-equity firms traditionally have avoided getting hedge funds to finance the deals, because they tend to be more aggressive than banks when it comes to seizing collateral in the event of a default.

Cynthia Koons contributed to this report.