Commentaries

Does securitization actually lower credit costs?

Just reading more of Fed Governor Tarullo’s speech and he has this to say about securitization markets:

There were undoubtedly many imprudent, even reckless, practices associated with the securitization process, particularly with respect to some exotic instruments whose risk could not be understood even by their creators. There is little to lament in their disappearance. But securitization is not in and of itself a bad thing. On the contrary, a well-functioning system for securitizing well-underwritten loans can make capital available at lower cost to businesses, homeowners, and retail consumers. The failure of many relatively straightforward securitization markets to revive without government support may be explained simply as a hangover from the excesses and still-encumbered assets of the pre-crisis period. Just as some have restarted, perhaps others will follow as markets for the underlying assets improve. But I will confess to some concern that there has not already been greater activity.

Interesting that he, too, is worried about the lackluster revival of securization even though the Fed has provided attractive non-recourse loans to those buying qualifying debt.

But I’m also interested in the assumption that securitization makes financing cheaper for consumers and businesses. I’ll buy that it makes credit more accessible since banks can move their loans off their balance sheets, but cheaper? This has been the conventional wisdom in markets for as long as I can remember, but has anyone actually done a study on it? If anyone has any thoughts on this, send them my way.

Kraft moving ahead with financing

Why let a little rejection stand in your way? Kraft is proceeding with the financing it would need to buy Cadbury, even though the U.K. confectioner spurned the initial offer. It looks like it’s financing plans are  above what had been initially expected, which could mean slightly more new cash could  be added to a revised bid.

Credit Suisse had put the new debt at $6.667 billion. Bloomberg reports it looks more like $8 billion.

Kraft Foods Inc., the world’s second-largest foodmaker, is in talks to arrange about $8 billion of financing for its bid to buy candy maker Cadbury Plc, according to two people with knowledge of the matter.

Citigroup Inc. and Deutsche Bank AG are working on setting up debt financing to cover about half of the 9.77 billion-pound ($16 billion) offer to buy Cadbury, said the people, who declined to be identified because the talks aren’t public. The financing would consist of a bridge loan to be repaid with the proceeds of an investment-grade bond offering, one of the people said. Officials from the two banks declined to comment.

They could also be using the new debt to refinance some of Cadbury’s outstanding debt of $2.4 billion.

The key remains that the financing is based on an investment-grade rating. The added financing isn’t likely to pressure the company’s ratings enough to make a junk rating more likely.

Moody’s Investors Service warned Tuesday that it could downgrade Kraft’s ratings if the deal goes through, but most likely would limit it to a one notch drop.

Leveraged loans making a comeback?

The $4 billion financing for Warner-Chilcott’s acquisition for P&G’s drug business is another sign of credit markets coming back to an even keel, but it’s not clear how much juice the banks have to keep the momentum going if they don’t find investors for the debt.

The Wall Street Journal reports that six banks, including JP Morgan and Bank of America, will provide the financing, $3 billion going to the acquisition and $1 billion to refinance existing Warner-Chilcott debt.

This would be the fourth-largest “leveraged loan” of 2009 in the U.S. and the largest globally for an acquisition, according to data provided by Dealogic. The last leveraged loan of this size for a deal in the U.S. was in April 2008, when Mars Inc. announced its planned purchase of Wrigley.

What’s not clear, however, is whether the banks are planning to hold on to the debt or pass it on to investors. Demand for leveraged loans has dried up since the collateralized debt obligation machine – which vacuumed up roughly 60% of leveraged loans- sputtered to a halt. If the banks aren’t re-selling the debt, I imagine there’s a limit to how much they can pony up for new deals, even with juicy fees.

The banks are in part attracted to the transaction because they can demand higher underwriting fees than during the last big deal-making cycle in the middle of the decade, said one person familiar with the deal.

According to Thomson Reuters, leverage loan volume so far this year has reached just $136.6 billion, through Aug 21, compared with $463 billion in 2008 and $1.1 trillion in 2007.

CIT doomed by PE

The most compelling argument for saving CIT Group from collapse is the impact it would have on small- and mid-sized business that depend on the New York-based lender for financing. But it’s increasingly looking like that argument is more hype than anything else.

First of all, CIT pretty much hasn’t been doing any new lending for the past six months, when its financial troubles really began to mount. Most of the lines of credit the firm has out to hundreds of thousands of small companies were arranged long before the collapse of Lehman Brothers.

Second, and maybe the best reason for letting CIT fail, is that a good number of CIT’s financing deals are with companies owned and operated by private equity firms. Our sister publication PEHub reports that in recent years, CIT has moved aggressively to provide financing to mid-sized companies that were taken over in leveraged buyouts. PEHUB has found at least 36 PE-owned companies that CIT is the primary lender to.

For instance, CIT has provided the bulk of the financing to Texas-based chain CiCi’s Pizza, acquired by Canadian private equity firm Onex in 2007. CIT’s financing has been provided the fuel for the chain’s rapid expansion.

Sure, the PE-owned companies are small- and mid-sized businesses. But this isn’t mom and pop we’re talking about here.

And CIT hasn’t just been a lender to PE-owned companies, it’s also arranged deals through its investment banking arm.

The case for saving CIT becomes a lot less compelling when you realize that an indirect beneficiary of keeping the lender afloat will be the strip-and-flip crowd. The idea of bailing out CIT to save the investment returns of PE funds isn’t too compelling. In fact, it would make for bad public policy.