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.