Morgan Stanley Takes Lending In-House

When Morgan Stanley Capital Partners, the investment bank's buyout arm, sought leveraged bank loans over the past few years to support acquisitions, it looked to commercial banks.

Now it need look no further than its own newly created shop for the attractive high-margin loans.

Early this month, Morgan Stanley hired Bankers Trust loan syndication chief Bram Smith to lead a senior lending operation, becoming the latest investment bank to start a lending group. Merrill Lynch & Co., Goldman, Sachs & Co., and Lehman Brothers all started such groups in the last few years.

Morgan Stanley is entering an extremely competitive and crowded lending business. But bankers said that the potential deal flow from its own buyout firm could generate several million dollars in underwriting revenue.

In the past few years, Morgan Stanley Capital Partners tapped banks for several sizable loans. In 1995, it borrowed $675 million from Bankers Trust New York Corp. and BankAmerica Corp. in connection with its acquisition of Silgan Corp., and $1.44 billion to refinance debt at Fort Howard Corp.

Bankers said that on a typical B-rated leveraged buyout credit, the lead bank looks to make approximately 1% in fees. Leveraged loans in the range of $1 billion for companies with single-B debt ratings could bring in around $10 million in fees.

"The emergence of a powerful competitor, particularly one that's potentially in control of in-house business, is not good news for the competition, including Bankers Trust and Chemical," said Raphael Soifer, a bank analyst at Brown Brothers Harriman & Co.

"I don't expect Morgan Stanley to jump in and sweep everyone out of the business," Mr. Soifer added.

A Morgan Stanley spokeswoman said it was too early to comment on the operation. But if the Goldman Sachs lending unit is a precedent, Mr. Smith and his nascent group could be busy with the company's own deals.

In late February, the Goldman Sachs lending group was tapped by Goldman Sachs Capital Partners to serve as syndication agent on an $815 million loan that supported the leveraged buyout of AMF Group, the bowling alley operator.

That deal, for which Citicorp acted as administrative agent, was well received in the marketplace.

Although lending and buyout operations in one company seem complementary, bankers said the lending team may have to work even harder than it would on other deals to win Morgan Stanley's leveraged business.

"The biggest challenge for Morgan Stanley's loan group is to sell its own firm on the product and on its capabilities," said Simon Jawitz, vice president and co-head of the bank loan group at Goldman Sachs.

Leading the debt and having a majority equity stake could present some problems down the road, bankers said.

"To some extent, you could argue that there's a conflict of interest," said Kevin Meenan, a principal at Meenan, McDevitt & Co. Equity and debtholders "have an adversarial role when it comes time to determine the terms, conditions, and coupons on a loan."

Mr. Meenan said that bankers have to maintain the firewalls between the different groups.

The issue is one of equitable subordination, in which a court can demote the position in bankruptcy of a debtholder with control over the company.

"Debtholders are supposed to have protections, but they can't demand how the company is run," said a loan syndicator. "If you have too much control, you no longer have debt status - you're equity."

Bankers said that this issue has not caused any problems for Goldman or anyone else at this point, but is certainly one that bankers would want resolved before joining a syndicate.

Investment banks can address this issue by bringing an administrative agent into a deal.

Bankers said that having investment banks as leads on deals could potentially give a range of commercial banks an opportunity to land administrative roles.

"If Mr. Smith is able to get Morgan Stanley even more aggressive in senior bank debt than they have been historically, that will add deal flow to the market," said Stephen Ceurvorst, the manager of loan syndications at Mellon Bank Corp. "We also hope that there will be more administrative agencies out for bid."

Bank lenders have high expectations for Mr. Smith, who joined Morgan Stanley two weeks ago.

"Bram Smith was an excellent choice for Morgan Stanley," said Glenn Marchak, senior vice president at Natwest Markets. "It was a real coup to get him."

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