Cracks in the edifice?

The FT reports today that the private-equity groups behind the biggest deal of recent times -- the $11bn SunGard Data deal -- are having trouble getting the financing. The bank group trying to put together a $3bn bridge loan for the deal are getting a "lukewarm" reception, and nobody seems to want the high-yield piece(s). The banks are supposedly very nervous -- that old joke about the so-called "bridge" turning into a "pier".

Meanwhile, a subprime lender from Southern California somewhere, name of Triad Financial Group, trying to do a buyout, had to scale back their $200mm high-yield deal to $150mm and up the coupon to 11 1/4 (for a B3/B- deal) to get their paper sold. The original talk on this deal was 9%. The last time subprime lenders had coupons like that was Metris, best I can remember, which very nearly went bust last year.

Meanwhile again, Deustsche Bank had to withdraw a $825mm issue that was supposed to fund the $2.6bn buyout of Masonite by KKR. Apparently DB had to eat the whole deal -- they really can't be liking that. If you can't get a deal done with the KKR name behind it, it's a sign of real trouble, methinks. There's quite a few private equity buyouts in the pipeline, pretty much all depending on the high-yield market to get them done.

In another interesting development, another reinsurer, Swiss company Converium, is being supoena'ed in the ongoing probe into MBIA. (Converium got into some pretty big trouble last year, too, as I recall). MBIA is the biggest bond insurer around. I'd say a huge chunk of the securitization market is backed by MBIA: they are the backing that gives comfort to all the investors in the AAA-rated top pieces in god knows how many trillions of mortgage, bond, credit card, and finance receivable deals. Well, I guess Fannie Mae is behind a lot of the mortgage deals -- real solid company there, what?

Maybe I'm just in a scare-mongering mood today, but this all looks like the beginning of a big shift in the debt markets. Treasuries remain calm, but I can see spreads over treasuries widening all over the place. And most of us are borrowing on spreads, not on the so-called "risk-free" rate. Take cover, chaps. The rebar is leaving the building..

Questions of refinement

Valero is taking over Premcor and in the process becoming the largest oil refiner in the country, with a capacity of 2.5 + 0.8 = 3.3mm barrels of oil a day. (The US consumes about 21mm barrels a day, so it's a pretty big chunk). Bigger even than Exxon. Pretty impressive. Not a good sign for us consumers, though, I would think: after the deal, there will only be 5 refining companies in the country, I hear -- a small enough group for price collusion to become very easy to do.

Right now, it's a very profitable business. "Crack spreads" -- the difference between the cost of a barrel and the price you can the resulting refined products at -- are apparently around $14 a barrel, which is surely about as high as it's ever been.

Here's a strange fact: no new refineries have been built in the US since 1976. This despite the fact that the industry is chronically close to 100% capacity (as you can imagine if you think about what our consumption has done since 1976). The environmental hurdles are, apparently, just too high. Makes you wonder, though, doesn't it? I mean, the oil industry is usually pretty good at getting what they want. Do you think it's possible they actually don't want any new refining capacity? They'd rather have $14 crack spreads perhaps. You'd think, too, they might make up the shortfall by building in Mexico, but that hasn't happened either... Odd.

I keep hearing, every time crude oil prices go up, that it's partly caused by "lack of refinery capacity". This is a proposition I don't understand. I mean, if refineries are too busy to accept more oil, wouldn't that have the opposite effect? Surely it would decrease the demand for oil, not increase it. If anybody out there knows why, I'd like to hear it.

Break up break up fees

Bankrupt Adelphia cable made a deal to sell to Time Warner and Comcast. I forget the size, somewhere around $17bn. Then Cablevision comes along, also wanting to buy. But part of the deal is a 2.5% break-up fee. In other words, if Adelphia backs out, it owes TWC about $400mm.

These break-up fees have become pretty standard in merger agreements. Obviously, though, they're not in the best interests of shareholders (where these are public companies) or creditors (in the case of bankruptcies like Adelphia).

Private companies can make whatever deals they want. For public companies, though, these fees should be outlawed.

Scotland Going Back Into China

The Royal Bank of Scotland is apparently contemplating an investment of up to $4bn for a 20% stake in Bank of China (which is the #2 or #3 bank in China), according to a story in today's FT. Under Chinese law, foreign investors can't own more than 20% of a Chinese bank, so they're ponying up for as much as they're allowed to.

The Chinese banking system is a bit of a mess. Under the strict central control of the Chinese Communist Party, the banks have apparently made loans to over 170,000 SOEs (State-Owned Enterprises, as opposed to the rather amusingly named SOBs or State-Owned Banks). Not surprisingly, that has resulted in enormous losses over the years, since the banks have been lending based on central policy (and, no doubt, bribery) rather than on economic merit. It's reckoned that non-performing loans in China's roughly $4 trillion portfolio of bank assets have been in the hundreds of billions.

On top of the bad loans, there's a very distinct smell of corruption. The Chairman of the China Construction Bank (CCB), another of the so-called "Big Four", recently resigned after being accused of taking a $1mm bribe. (This came to light when a Chinese company filed in California court against an American IT company, Alltell Information Services, which it accused of reneging on a deal to pay it a commission. Alltell is accused of paying the $1mm to the bank chief, as well as a trip to Pebble Beach and his son's school fees, to kill this deal -- the broker's lot is not always a happy one, to be sure). The previous chairman of the same bank is already in jail for taking bribes while head of the Bank of China. The corruption isn't only at the top, evidently: the manager of a sub-branch of BoC has gone missing along with $120mm; several senior staff of the same bank were found to have loaned $78mm to a property developer using fake documents; a group of staff at CCB is accused of making off with $14mm in 98 separate scams; a lone typist at the bank's Dalian branch is accused of embezzling $6mm over the years to feed his gambling habit. It looks pretty much as though baksheesh is endemic in the banking system -- and you can probably extrapolate that to the economy as a whole.

The authorities want to take its banks public. The reasoning behind the decision is good: with the discipline of public ownership, these banks will have to get their act together. And they need to get their act together by 2006, when, under an agreement with the WTO, foreign banks will be allowed in to compete. But it's not an easy proposition after this kind of publicity. It doesn't help, either, that other IPOs of state owned enterprises have performed very badly in the aftermarket -- mainly because managements have, effectively, walked off with the proceeds. The Chinese government has so far had to inject $45bn into the two big IPO candidates (CCB and BoC) to make their balance sheets acceptable to potential investors.

Who would want to invest in this mess? Well, just about every international bank, apparently. ING, the Dutch financial group that mopped up Barings after the Nicholas Leeson debacle 10 years ago, is buying up to 19.9% of Bank of Beijing (along with 5% to be taken up by IFC, the World Bank's private equity sub). And there are plenty of rivals lined up alongside RBS for a piece of BoC, or any other bank that comes up for grabs. Not hard to see why: those 1.3bn Chinese, and the (apparently, anyway) booming Chinese economy (now, at something like $1.5 trillion, overtaking France to be the 5th largest in the world after the US [$11], Japan [$4.5], Germany [$2.5] and the UK [$1.9] ).

On an apparently unrelated matter: Khordorkovsky made a defiant closing speech at his trial in Russia for embezzlement, fraud and tax evasion. K probably stole Yukos in the early 1990s when Russia's state assets were "privatized" -- sort of like China's are being now. It's reckoned "the oligarchs" got a lot of prime stuff very cheap under Yeltsin. Putin has been clawing the assets back -- first the media companies, then the oil and gas. K was very high profile in his opposition to Putin, so they're making an example of him. Meanwhile, they've pretty much grabbed back Yukos by burying it under tax claims (the amount of the claims, apparently, aren't far short of total revenues, so they look pretty bogus). Although some western investors have continued pouring money in despite this apparent disregard for property laws, it has scared, net net, about $9.5bn out of the country. An object lesson, I would think, for RBS.