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July 1st, 2008

One Of The Most Well Known Rock Groups Of The Late Sixties And Early Seventies Was “Three Dog Night.”

One of the most well known rock groups of the late sixties and early seventies was “Three Dog Night.” The name of the group was drawn from a practice of the Australian Aborigines who would sleep next to a dog at night to stay warm. The coldest of all nights required three dogs and was known as a three dog night. The domestic credit markets spent the first quarter of 2008 in a Three Dog Night. Conversations with what were major lenders, now known as major observers, as they now offer to take payment for their advice on how a business would be financed rather than get paid to provide actual financing, are entertaining.

Ironically, the absence of banks from the lending business is at a moment in time when the reward for the risk taken is as high as it has been in three decades. Despite the Fed’s efforts, by lowering rates, to make us Sharia compliant, the senior lending community is immune to the Fed’s moves. Today’s secured senior debt pricing is LIBOR +500 basis points, with LIBOR artificially defined to have a floor of 3.5%, total senior leverage of 3.0x , total leverage of 4.5x with the debt being issued at 98 accompanying a 2 ½ point fee for funding. Twelve months ago the same loan was LIBOR +275 basis points, no floor, 4.0x senior 5.5x total borrowing, issued at par with a two point fee. The best risk-adjusted place to be today, on an LBO balance sheet, is in that of senior secured debt, yet there are few willing occupants. Bank charters historically have been granted pursuant to an intention of the bank to lend money, but as Three Dog Night told us, it is “Easy to be Hard”. It is just not always wise.

Olympus is now in its twentieth year. A certain sense of déjà vu pervades our days. When we began our investing in the late eighties the LBO business was beginning to fester from excess leverage and the use of pay-in-kind securities when adequate cash for debt service was unavailable. Today the past is mirrored as the LBO business is festering from excess leverage and from the use of toggle bonds, when adequate cash for debt service is unavailable.

A recent Wall Street Journal article asked the question “Does Being Ethical Pay?” Whether it pays or not, most remarkable is the title’s implication that being ethical needs to be justified by financial reward. We are beginning to see a number of litigations where firms that over leveraged their purchases are now pursuing scorched-earth legal strategies attempting to extract money in court from the lenders and the sellers or to abrogate the purchase agreements they signed. Paying sellers breakup fees to not complete deals, a remarkable comment on the underwriting that led them to sign a purchase contract, is now de rigueur. In other cases, sponsors are suing lenders that are unwilling to fund, to force funding on doomed deals, to avoid paying breakup fees, to collect deal monitoring/closing fees or to use the lender’s intransigence as leverage to lower the purchase price offered to sellers.

I’m Rob Morris and I approved this blog.

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