Lenders backing Norfolk Southern's hostile bid for Conrail breathed a sigh of relief this week as Conrail began negotiating a friendly merger agreement with CSX Corp.
About 60 banks had signed on to a $13 billion loan for Norfolk Southern, led by Merrill Lynch & Co. and J.P. Morgan & Co. That loan may now be cut in half or disappear altogether.
Either outcome would suit many of Norfolk's lenders just fine. Several of the domestic and international banks that had committed themselves to the loan underpinning the hostile bid were concerned that they would be left holding large pieces of potentially noninvestment-grade debt.
"The general view was that (Norfolk's) senior unsecured rating would go just below investment grade" if it won all of Conrail, said a lender in the deal. "Now, with less leverage, they'll probably be investment grade."
Conrail, which has been the target of a bidding war between CSX and Norfolk Southern since October, is now expected to sell itself to CSX for $10.5 billion. The resulting railroad is then expected to divest some of its assets to Norfolk Southern.
"This is really good news for banks," said a syndicated lender not associated with the deal.
Lenders to Norfolk received high fees for backing the company's hostile bid. Indeed, those that committed $500 million got a $1 million flat fee in addition to other cash rewards.
But the loan had another potential cost for Norfolk Southern. If it drew the entire $13 billion, it risked losing its coveted investment-grade rating. That would give some of its banks large exposures to a leveraged company. Banks would have a hard time reducing that exposure given the broad distribution of the Norfolk loan.
Now bankers are speculating that the Norfolk, Va., railroad will need to tap, at most, half of the blockbuster loan. They say a smaller loan would increase the scarcity value of Norfolk's debt and make the fees even more attractive.
"It's a huge home run because it increases the value on a percentage basis of the fees," said a syndicated lender.
Some bankers said Norfolk wouldn't tap the loan at all, choosing to use the public capital markets instead.
Meanwhile, a $4 billion loan to CSX led by Chase Manhattan Corp., BankAmerica Corp., Citicorp, and NationsBank Corp. is not expected to change. Unlike Norfolk Southern, CSX made a cash and stock offer for Conrail. As a result, CSX does not need to take on more debt to finance its final, larger bid.
"They've kept the cash portion the same and bumped up the stock portion," said a banker familiar with CSX.
CSX would likely pay down its loan if it sells Conrail assets to Norfolk Southern, said lenders.
A spokesman for Norfolk Southern said CSX and Conrail have yet to sign a formal merger agreement. A joint purchase with Norfolk Southern remains a possibility, he added.