Want to get rid of your leveraged loans quickly? Don’t sweat.

http://ftalphaville.ft.com/


The Real Deal: beware the banks’ UFOs
Oct 08 07:22
by Lina Saigol
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(1 comment)

Want to get rid of your leveraged loans quickly? Don’t sweat.

All you have to do is leverage up the leverage by creating a new vehicle. Let’s call them UFOs (or Unidentified Financing Objects).

These have a standard CLO structure, More…

Want to get rid of your leveraged loans quickly? Don’t sweat.

All you have to do is leverage up the leverage by creating a new vehicle. Let’s call them UFOs (or Unidentified Financing Objects).

These have a standard CLO structure, but they remain private, are controlled by the banks and are designed to help shift the catalogue of leveraged loans stuck on their balance sheets from financing deals.

Here’s how they work.

The bank holding the loans teams up with a hedge fund, or a buy-out group. Together, they create a UFO to buy selective loans at the current market discount, say 96 cents in the dollar, from themselves.

The bank, which owns the loans at par value, takes the write-off, but gets to hold on to the better quality debt tranches, which it can carry at a much lower cost of capital.

The hedge fund/buyout group takes the highly-leveraged “first loss” or an equity slice of the UFO, in the hope that it can make profit on the underlying loans when they return to par value at maturity or when the debt is refinanced.

The banks say these UFOs are a pure creative genius, that they do the market a favour by creating liquidity where there is none, and help lift the secondary prices of the loans by demonstrating demand.

Meanwhile, they can get a substantial return on the senior slices of debt - at least relative to their cost of funding and the risk capital they are required to hold.

But the credit squeeze means there are hardly any new CLOs to absorb the current loans on offer, so it’s only the bank-sponsored UFOs that can snap up these loans.

It’s like selling your house and giving the buyer the financing. Have you really offloaded it, and is the price a real market price?

These UFOs are not a reflection of real demand driving improving leveraged loan prices.

These new vehicles being created in a stagnant market are merely a stealthy way of financially-engineering the burden of costly risk away from the bank.

It all looks a bit like a close encounter with the wrong kind. Another leveraged solution to an already leveraged problem isn’t a way out of the credit crunch.

Unidentified Financing Objects ! Ha, ha, ha...

 

CDO, CLO, why r they always 3 letters abbreviated