Big Banks Speak Out in Support of LBOs

Big U.S. banks, bothered by the publicity given to their newest lending area, corporate buyouts, are beginning to speak out in defense of their leveraged buyout activities after playing them down for months.

The chairman of Bankers Trust New York Corp., a leader in the field, told a group of banking analysts this week that the bank was not concerned about the safety of its $2.7-billion leveraged buyout portfolio.

“I don’t think we have an undue concentration,” said Chairman Charles Sanford, addressing the growing concern among analysts and economists that banks may be overextending themselves in LBO lending. His remarks broke the banks’ silence on this area, something that had begun to aggravate industry analysts who try to follow banks’ activities and gauge their soundness and profitability.

Bankers, unwilling in the past to discuss their LBO lending, claimed that LBO loans cannot be broken out, in part because buyouts cannot be clearly defined.

Brokerage house Keefe Bruyette & Woods in September sent an open letter to LBO banks lenders. “You do have leveraged buyout loans, and frankly we don’t know whether they smell or not. My guess is, you really don’t know either,” it said.

Other heavy LBO lenders include Wells Fargo Corp., BankAmerica Corp., Citicorp, Security Pacific in Los Angeles and Manufacturers Hanover Corp.

Economists like Robert Gay of Morgan Stanley & Co. say the LBO lending business could turn sour if a recession occurs, making it hard for leveraged companies to service their debt.

And in October, Federal Reserve Chairman Alan Greenspan cautioned U.S. banks to watch their LBO lending.

Higher Rate

In a typical LBO, a group of investors puts up a small amount of money and borrows up to 10 times more to take a company private. The new owners repay the debt by peeling off assets, selling them and tapping the cash flow.

Bankers Trust defines LBOs as transactions in which the proportion of debt to capitalization is 70% or greater.

Among the creditors, banks are senior lenders, which means they are first in line to get paid. But that is little comfort to analysts who watched the leading U.S. banks get mired in Latin American lending in the 1970s because the business seemed easy and profitable then.

Although Bankers Trust, one of the lenders involved in the $25-billion RJR Nabisco Inc. buyout, would not disclose the profitability of its LBO loans, which constitute 11% of its portfolio, the business appears to be highly profitable.

Analysts say LBO loans typically fetch interest of 1 to 2 percentage points above the prime rate, currently at 10.5%.

Bankers Trust, which was also involved in the Burlington Industries and Fort Howard Corp. buyouts, told analysts that it originated $60 billion in LBO loans in the past three years but said it has sold big pieces of those loans to other U.S. and foreign banks, thrifts and insurance firms. Sanford said Bankers Trust has only one loan larger than $100 million and it plans to sell parts of that as soon as possible.

He also said Bankers Trust’s LBO portfolio was diversified across a wide range of industries.

That is a key difference between LBO lending and other categories, said a spokesman for Bankers Trust. “People talk about LBOs as though they were an industry or regional concentration like energy, real estate and agriculture. A well-managed LBO portfolio is highly diversified among a number of industries,” he said.

George Salem of Prudential-Bache Securities, among the first to raise a warning flag about the banks’ LBO activities, said LBOs did not appear to be the banks’ next trouble spot.

Lack of Evidence

In a report issued in late October, Salem said there was no evidence that bought-out firms were having trouble repaying their debt, adding that the economy did not appear headed toward recession.

“We have been reluctant to embark on a full research project on the quality of LBO debt because of the virtual absence of public data,” Salem said.

However, he added, “there is no panic to do this research” as only one LBO, Revco DS Inc., has gone belly-up so far.

Sanford said Wednesday that despite calls to clamp down on leveraged buyouts and other mega-deals, “one thing the government will not do is stop mergers and acquisitions.” In fact, he said, the activity was likely to pick up as foreign markets followed the U.S. lead.