Loans: More Liquid Than Bonds

There are impressive financings, and then there are mind-blowing financings.

And they way that KKR is raising $24 billion to fund its acquisition of First

Data definitely falls into the latter camp.

Item: KKR will use First Data to issue $8

billion of junk bonds to help pay back the purchase price. That will be

the largest junk-bond issue of all time.

And that’s just the beginning: the largest junk-bond issue of all time is a

mere one third of the total amount of debt financing that KKR is lining

up. The other $16 billion is coming from the

loan market – and all of it is "cov-lite".

When is a loan not a loan? When it’s "cov-lite" – which is

to say that it lacks the covenants (investor protections) that conventionally

distinguish loans from bonds. A cov-lite loan is the worst of both worlds, from

an investor point of view: it doesn’t have the liquidity of a bond, and it doesn’t

have the protections accorded by a loan.

But a $16 billion loan is always going to be pretty liquid, and it will be

distributed to so many banks and hedge funds that maybe the cov-lite option

makes sense. After all, trying to get them all in a room to agree to any modification

of the loan agreement would pose an enormous collective-action problem in and

of itself.

In any case, it’s interesting to me that KKR is finding it easier to raise

money in the loan market than in the bond market. Why? There’s a clue in a comment

from jck on a post of mine earlier today:

The frothy market is for CDS, bond prices have been tanking pretty steadily

for about 3 months.

In English, issuing bonds is expensive, and the yields that companies such

as First Data have to pay to get their bonds out are quite high by the standards

of a few months ago. Meanwhile, buying protection against a loan default has

never been cheaper. So the banks can happily lend $16 billion to First Data,

and then hedge their credit risk in the CDS market.

Who’s selling all that protection? Is it still CDOs? That I don’t know. But

I do get the feeling that if the First Data loan ever does default, the managers

will end up dealing with a very large number of non-bank players from the world

of credit derivatives: not your father’s creditors’ committee, by any means.

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