LBO deals may be early risk signal: strategists

By Dena Aubin

NEW YORK (Reuters) - The aftershock if a corporate takeover fails to get financing is one of the biggest potential threats to the credit markets this year, fixed-income strategists said this week.

As funding needs for a record buyout spree swell, a sign that credit is getting tighter could send reverberations through several markets, Gregory Peters, Morgan Stanley's chief U.S. credit strategist, told the Reuters Investment Outlook Summit in New York.

"If there's one thing that concerns me more than anything else for the markets writ large, and that includes equities, it's one of these deals getting announced that can't get financed," he said.

"That really creates a crisis of confidence in the system that halts anything else from getting financed," Peters said.

Private equity players are keeping a close watch on the credit markets as the backlog of takeover financings grows.

Funding needs for leveraged buyouts now total about $301 billion, including about $89 billion of bonds and $212 billion of loans, according to a Bear Stearns report this week.

Risk premiums, or the extra yields that companies pay to sell bonds, have not risen in a sustained way in more than two years, though there have been temporary bouts of widening over that time.

Such bouts of "risk flares" could become more frequent, even as the world economy remains in good shape, said Jack Malvey, Lehman Brothers' chief global fixed-income strategist.

"Well before the real recessions, we tend to have these capital market risk flares," Malvey said. "Over the course of the next two to three years, you will have these well before you begin to see outright real recession."

Leveraging risk will also remain paramount in the corporate bond market as private equity firms continue to do debt-financed deals, said Glenn Reynolds, chief executive of independent research service CreditSights.

"All the stars are in alignment to do a lot more of these types of deals and continue to break all records," he said.

The top risk for a significant credit market downturn, though, would be an external shock, such as if there were bad trades in currency or commodity markets that sparked widespread forced selling, he said.

"There's really nothing to unsettle (corporate bonds) unless you start to really see a big technical whipsaw," Reynolds said. Though LBOs have caused some selective widening of yield spreads, the broad corporate bond market is being supported by strong demand for fixed-income assets, he said.

Indeed, risk premiums have been surprisingly stable even as inflation worries sparked a vicious sell-off in benchmark Treasuries in recent days.

Average yields on investment-grade corporate bonds have risen just 2 basis points this month to 96 basis points more than Treasuries, while junk bond yields are up just 7 basis points to 253 basis points over Treasuries, according to Merrill Lynch data.  Continued...