Kohlberg Kravis Roberts & Co. is at it again, trying to push what many bankers believe is an aggressively structured bank loan through the market.
Canadian Imperial Bank of Commerce and Bank of Nova Scotia, along with Merrill Lynch & Co., have agreed to fully underwrite the $1.1 billion loan for New York-based KKR. The loan is funding Shoppers Drug Mart, a Canadian drug store chain that KKR bought from Imasco Ltd. in November for $1.7 billion.
That financial institutions continue to participate in such loans despite the red flags they raise continues to fascinate industry analysts and observers. The consensus is that in the end the banks conclude that the less-than-favorable terms being offered are offset by the potential benefits of winning a closer relationship with KKR.
"Only the good ones, like KKR, can get away with it," said David Keisman, a loan and bankruptcy analyst with Portfolio Management Data LLC.
The Shoppers Drug loan is a tough sell because it is secured by stock in Shoppers Drug. On top of that, Shoppers Drug is looking to gain traction in the retail drug market, a notoriously rough space to do business in these days.
Investors also are unwilling to invest in such loans because they pay less than the company's unsecured bonds.
The deal does have some appealing characteristics. On the surface, it appears to be a perfect match and an easy sell for CIBC and Nova Scotia. Not only is Shoppers Drug Mart a leading name in Canada, KKR is among the most sought-after bank customers because the financial sponsor often returns to its favorite banks for business.
But as terms of the Shoppers Drug Mart loan emerge, bankers and investors are grumbling about the loan's obvious collateral problems. Unlike most loans, the Shoppers Drug Mart loan is secured through company stock rather than assets such as real estate, accounts receivable, or inventory.
Such loans have been targeted by regulators, including the Office of the Comptroller of the Currency, as unacceptably risky for banks and investors. "People are getting tired of it," said Mr. Keisman. "We're seeing less and less of this kind of deal."
"Clearly the institutional market prefers tangible assets to stock," said Arrington Mixon, head of U.S. loan origination for Bank of America Corp.
"KKR has historically pushed structures and they've never had a situation where they've pledged real assets," said a banker familiar with the deal. "They've been able to get away with it [because] they control a tremendous amount of deal flow."
CIBC, Scotiabank, and Merrill Lynch will soon find out if KKR can get away with it again. The Canadian banks have each underwritten 37.5% of the deal, with Merrill taking the remaining 25%. The bankers met in Toronto shortly before Christmas to discuss the deal and set pricing.
They plan to test U.S. investor interest at a bank meeting in New York within the next two weeks.
Rob Mustard, a managing director of loan syndications at Scotiabank declined to comment on the deal. Frank Brittan, head of lending at CIBC, and John F. Yang, head of global loan syndications at Merrill Lynch, did not return phone calls.
At least one banker in the syndicate acknowledged the KKR deal will be a tough sell saying it "sounds like Bruno's all over again" - referring to the bankrupt supermarket chain that KKR bought in 1995.
In a lawsuit, bondholders have accused KKR of illegally transferring wealth in the Bruno's deal and both sides are fighting over a reorganization plan that would give ownership of the supermarket chain to banks, not bondholders. Banks, which own almost worthless Bruno's stock, are hoping to see any kind of return on the deal.
Other bankers say the Shoppers Drug Mart loan more closely resembles KKR's fourth-quarter deal for Alliance Imaging Inc. That $616 million loan's thin returns were largely shunned by the bank market, leaving lead arrangers Deutsche Bank AG, Citigroup Inc., and J.P. Morgan & Co. holding a majority of the fully underwritten amount.
That loan capped a run of KKR deals that, although they fared better in syndication, lost as much as 40% of their face value when the loans began to trade in the secondary market.
But bankers also say the Shoppers Drug Mart deal doesn't have "the greed factor" or lucrative returns necessary to turn investors attention away from its thin collateral. Most B-rated loans originated in December are paying the London interbank offered rate plus 350 basis points, according to Portfolio Management.
The $241 million revolving credit facility and a $345 million seven-year term loan are priced at Libor plus 325 basis points. The deal has two institutional tranches of $259 million, each priced at Libor plus 350 basis points - a fee that can move higher should the company's debt increase - and maturing in eight and nine years, respectively.
"CIBC, Scotia, and Merrill tried to convince themselves that Shoppers would be different than Alliance," a banker close the deal said. "Maybe they though there was better pricing but what they're going to find is that their [KKR's] sway has diminished a little bit."
Ultimately, with little security or payoff, CIBC faces an uphill battle during the next few weeks in selling down the loan. One banker put the deal's chances of failing at 70%, but added that the deal would likely be recut and resyndicated.
"It's not in KKR's interest to have just three banks holding the loan," the banker said. "But why not roll the dice and see if you can get it done? There's still a 30% chance."
