The end of the credit party

The once-endless stream of cheap credit is starting to dry up; buyouts, corporate deals take a hit.

By Grace Wong, staff writer

LONDON ( -- Dealmakers, investors and home owners in the United States are facing a grim summer as conditions for borrowers get worse.

Until recently, there has been a seemingly unlimited supply of cheap money to fuel leveraged buyouts and other takeovers. There was also an easy flow of mortgage money available before the housing market turned south and the crisis erupted in subprime mortgages made to borrowers with poor credit.

But now investors are showing a greater disdain for risky debt - and fears about a looming credit crunch have shaken investor confidence worldwide. The Dow Jones industrial average plunged 311 points Thursday - its second-worst day of the year - and sent global stock markets reeling. The Dow opened lower Friday as well but later stabilized and was little changed in mid-morning.

Besides triggering a global stock selloff, the jitters are casting a shadow on the buyout boom and could slow down everything from private equity deals to corporate restructuring plans.

The housing market, meanwhile, is still struggling to find a bottom. The subprime meltdown started the worries in credit markets - and the extent of the problems in the subprime mortgage market remains uncertain.

"The ultimate outcome of the decline in mortgage credit quality is not wholly predictable," Moody's said in a July 26 report. While there are efforts being made to forestall the surge in foreclosures, "the downside risks outweigh the positives," the report said.

Credit markets have been roiled as investors have begun shying away from risk, demanding better terms on corporate bonds and loans, meaning the old days of cheap, easy money for corporations may be past.

"This is part of a process of removing liquidity and increasing the expected returns required of people to tolerate risk," Charles Diebel, an analyst at Nomura International, said about the turbulence in the market.

Tighter credit is troubling to investors for two reasons. It's likely to slow the buyout boom that's helped prop up stock prices. And it could raise the cost of borrowing for companies, hurting corporate earnings. To date, there have been roughly 20 buyout-related debt deals that have been postponed as credit markets have tightened.

Earlier this week, Chrysler delayed a debt sale related to its takeover by Cerberus Capital Management. The sale of $12 billion in loans underwritten by JP Morgan (Charts, Fortune 500), Bear Stearns (Charts, Fortune 500), Goldman Sachs (Charts, Fortune 500), Citigroup (Charts, Fortune 500) and Morgan Stanley (Charts, Fortune 500) was put on hold, according to Reuters Loan Pricing Corp. - although Cerberus said its purchase of Chrysler would still be completed in August.

The wave of credit worries is also upsetting corporate plans in
Europe. British pharmacy giant Alliance Boots, which is being taken over by Kohlberg Kravis Roberts and an Alliance executive, ran into trouble financing its buyout earlier this week.

Britain's Cadbury Schweppes said Friday it's delaying the sale of its beverage unit because of troubles in the debt markets. The company said it pushed back the timetable of the sale "to allow bidders to complete their proposals against a more stable debt financing market."

Now there are concerns the darkening mood in the debt market could hit other big deals in the pipeline. A number of high-profile buyouts still need to be financed, including the $28 billion purchase of wireless phone company Alltel (Charts, Fortune 500) and the $44 billion takeover of Texas utility TXU Corp (Charts, Fortune 500).

"Clearly, deals will get done. But capacity again has become an issue. Syndicating a $5 billion loan once again seems daunting, arrangers say, to speak nothing of a $10-15 billion credit," Standard & Poor's Leveraged Commentary & Data said in a note Thursday.

If financing for buyout firms dries up, overall deal activity would be hit hard. Private equity firms have announced about $782 billion in deals this year, or about a quarter of worldwide deal activity, according to Thomson Financial.

The weak conditions also come when buyout firms may start crowding the exit doors, which would make it more difficult for other deals coming along.

Given the length of the current merger wave, which started in 2003, the M&A market is already ripe for a drop off, according to Scott Moeller, a visiting professor of finance at Cass Business School.

"At some point, this market will go down, and because of the way liquidity has driven this merger wave, when we have the fall - it's going to be steeper, and the drop is likely going to be faster than in the past," he said.

Private equity firms typically hold their investments for three to five years. The question now is will they be forced to start unloading the firms scooped up in the recent buying spree sooner than they had wanted.

It remains to be seen what will trigger the selling wave among private equity firms, but when liquidity starts to dry up, "everyone is going to rush to the exits," Moeller said. Top of page