Thursday, August 14, 2008

NewSpeak Watch: What Does "Sale" Mean? (LBO Loan Edition)

(Naked Capitalism) Ah how distant early 2007 seems. Remember how the private equity business was going gangbusters, M&A was at record levels, and no deal was too big to get done. Then the credit markets hit the wall, leaving a lot of investment banks holding LBO debt that they hadn't sold (the most common mechanism had been collateralized loan obligations.

But then the clouds parted and banks reported that they were selling the LBO debt that had been crudding up their balance sheets, admittedly at a loss. Everyone agreed that this was a Good Thing, that the banks were putting their problems behind them.

Of course, there was the inconvenient fact that some, perhaps many, of these so-called sales were in fact financed, but few appeared inclined to question the sunny view that progress was being made.

The Financial Times has unearthed some juicy details of the terms of these financings. In particular, the amount of the loan relative to the nominal amount of the sale is, shall we say, impressive.

To review typical terms:

Loan was sold for 85 cents on the dollar

Sale was 80% financed. This means that the sale proceeds were a mere 20% of the discounted amount; the rest of the loan balance is contingent on whether the loan performs (ie, the buyer takes the first loss, which is equal to the cash paid; the FT isn't explicit, but it appears further losses result in a dollar for dollar reduction in the loan balance).

The interest on the loan is at less than market rates. In economic terms, that means the bank got even less than the mere 20% cash amount (you'd need to reduce that amount by the value of the discount on the financing)
I suspect this item will not get the attention it warrants. It's another illustration of the fact that much of the supposed improvement in the credit markets is a function of smoke and mirrors and unprecedented central bank interventions.

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