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Today is a good day," uttered a partner at a private equity firm March 17, in reaction to news that J.P. Morgan Chase & Co., with help from the Federal Reserve, was buying Bear Stearns Cos. for a paltry $2 a share. And why not? The Fed also announced it had created a lending facility that would allow broker-dealers to access overnight loans at the same terms as commercial banks borrowing from the discount window, thus potentially alleviating the kind of liquidity run that felled Bear. Of course, not everyone was cheering. That same day another Wall Streeter branded the sale of Bear a "raping" of the firm's shareholders, who had seen their holdings shrink from $3.5 billion on Friday to $236 million on Sunday night. Still, the belief that the multipronged Fed initiative might finally stabilize the financial system was a predominant emotion as the week went on with Lehman Brothers Inc. surviving and the stock market surging. Is our private equity maven right? Did Bear's demise represent a bottom? You've got to be very careful calling a bottom, but there are a few indications that markets -- especially those in leveraged credit -- are showing signs of life. This is creating a sense that wheels of corporate finance may, though slowly, begin to turn again. Take, for instance, word that Blackstone Group LP's debt group is on the verge of closing two collateralized loan obligation funds to invest in leveraged loans. The evaporation of CLO demand has been one of the main reasons for the freeze that descended on the leveraged loan market last summer and forced Wall Street banks to take write-downs on billions of dollars in loans they agreed to lend, but couldn't syndicate in the absence of demand. According to sources, J.P. Morgan, which arguably escaped the worst of the subprime debacle, and Japan's Norinchukin Bank are investing separately in the triple-A tranches of two CLOs of $500 million each. The investors will likely receive interest over LIBOR plus 100 basis points for their trouble. That's much higher than the LIBOR-plus-20 basis-point rates triple-A tranches commanded at the peak of the credit boom, but enough, it seems, to entice some investors back. "It's a great time to invest," says one debt-market investor, who notes that loan prices for good credits such as Texas utility Energy Future Holdings Corp., formerly TXU Corp., are trading below 90% of par, representing an opportunity for those who believe the loan will eventually return to above par. Of course, that belief that buyers would reappear in a beaten-down market has been oft repeated by opportunistic loan funds over the past several months, but little real demand resulted from it. That can be explained by investors' unwillingness to jump into the market when the perception was that prices were only going to slip further -- the by now famous "falling-knife" scenario. Several opportunistic buyers were bloodied in October after they piled in during a brief respite in secondary markets, only to see the value of their recent purchases plummet. Whether that happens again is anybody's guess, but one investor says the Fed's moves, including the creation of a 28-day repurchase facility announced March 7, have given comfort that investment banks now have the ability to trade toxic mortagage-backed debt for highly rated treasuries, which could give them relief from near-continuous write-downs. That might be enough to give the banks enough comfort to sell loans to clear space on their balance sheets even if sales produce losses. Although two new CLOs from Blackstone do not represent enough demand to sop up the estimated $200 billion of committed debt still on banks' books, their creation follows another interesting event, which represents another potential source of demand. Last month, Citadel Broadcasting Corp. approached its lenders, led by arranger J.P. Morgan, to buy back its debt in a Dutch auction. Lenders would tender to sell the loans at less than par value, and Citadel could retire about $200 million of its $1.53 billion loan at a significant discount to par. The proposal, which lenders approved March 12, ran counter to general practice in the loan market, where it is common for companies with cash to spare (left over after taxes, capital expenditures and any other obligations) to have to pay down their debt at par value through what is termed an "excess cash flow sweep" covenant. Citadel, it seems, lacked such a covenant and could have used its spare cash by providing a dividend to shareholders but decided that taking out debt was better. Although the range at which Citadel set the auction -- between 74% and 80% of par value -- was seen as disappointing, some felt corporate buybacks could create demand for discounted loans. Standard & Poor's Leveraged Commentary & Data unit points out, however, that such potential buybacks are limited. According to S&P data, some 88% of loans in the S&P/Loan Syndications and Trading Association index of leveraged loans contain the covenants, representing $472 billion of the $556 billion in total volume. In addition, with loans trading in the range of 85% to 90% of par, forcing borrowers to take them out at par seems very attractive to lenders. But there are advantages to Citadel's gambit. "In the end, a series of Dutch auctions would help heal the market by retiring paper and shrinking supply," S&P analyst Steve Miller wrote. Regulators' willingness to support the wobbly banking system and the return of activity in the markets and innovative strategies to deal with the backlog are hopeful notes in the cacophony of bad news. But that doesn't mean the market's troubles are over. In fact, another troubling sign surfaced March 18 when retailer Michaels Stores Inc., owned by Blackstone and Bain Capital LLC, announced disappointing fourth-quarter sales figures, prompting the resignation of CFO Jeffrey Boyer. The highly levered company's loans fell to 80% of par, while the bonds traded at 73%. A major default by an LBO-backed company might render the still-fugitive optimism in the loan markets moot. "It certainly isn't going to make anyone feel better," one banker says. - Vipal Monga Related coverage:
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