forbes.com
Other People's Money
By Seth Lubove
LOOKING DOWN LAS VEGAS' bustling Strip, you
wouldn't know that casino stocks were in the
tank long before the latest market turmoil, with
Mirage Resorts down from $30.38 to $17.75,
and Circus Circus from $26.50 to $10.
Construction cranes dot the sky, adding ever
more rooms, slots and restaurants in an already
glutted market.
What's going on here? The answer is that the low
stock prices haven't slowed expansion because
the casino operators can currently get all the
cheap capital they want by tapping yield-hungry
mutual funds and other investing institutions. At a
time when Treasury yields have sunk to 30-year
lows, mutual funds, hedge funds, insurance
companies and other big investors are gobbling
up anything that offers a few percentage points in
higher yield and relative safety.
Much of the new money is in junk loans rather
than in junk bonds. What's the difference? Unlike
a bond, which is issued directly by a company
and underwritten by an investment bank, junk
loans are syndicated loans that are divvied up
among nonbank investors as well as traditional
banks.
In the first half of this year alone the market
absorbed $140 billion in junk loans, compared
with about $111 billion in junk bonds. This
compares with $194 billion in junk loans for all of
1997.
Richard Goeglein, president and chief executive
of Aladdin Gaming Holdings LLC, was prepared
to float more than $400 million in costly junk
bonds last summer to fund the construction of the
new Aladdin Hotel & Casino on the Strip. But his
investment bankers, Mark Sunshine and Daniel
Alpert of Westwood Capital in New York,
ditched those plans and rang up Bank of Nova
Scotia and Merrill Lynch Capital Corp. The
bankers arranged a $410 million leveraged loan
syndication for the $826.2 million project (the
rest of the funding comes from joint venture
partners, equity and a smaller junk bond
offering). By going the junk loan route, Aladdin
needed to pay only a little over a 10% blended
cost of financing, versus nearly 12% for a Strip
hotel that used almost all junk bonds, as well as
lower underwriting fees.
Whereas junk bonds can be sold to the public or
to junk bond funds, junk loans can tap a fresh
market: so-called prime rate mutual funds, which
are mutual funds that buy leveraged loan
participations. While the interest coupons are
slightly lower than with junk bonds, the loans are
floating-rate debt that's adjusted for interest rate
fluctuations and, because it's senior secured bank
debt, is higher in the pecking order in a default.
Which is why prime rate funds can buy them.
Howard Tiffen, manager of Pilgrim America's
Prime Rate Trust, says that in exchange for giving
up from 1% to 3% of yield compared with a junk
bond, he gets up to an 85% recovery in a default,
in contrast to about 35% if a junk bond tanks.
This all started when banks decided to cash in on
Wall Street's junk bond business. Money-center
banks could make the high interest loans and then
peddle them to smaller banks and mutual funds,
thus cutting out the traditional junk bond
underwriters. Unwilling to miss out on the party, a
number of Wall Street houses, Merrill among
them, got into the junk loan business themselves.
As with junk bonds, there's now a thriving
secondary market in the loan pieces.
But debt is debt and leverage is leverage, and
someone is going to get burned occasionally. The
Pilgrim fund owns loans from the wobbly Boston
Chicken, as well as Nextel Communications and
something called Murray's Discount Auto Parts.
Defenders of these loans argue that they are safer
than junk bonds because as bank debt they
outrank junk bonds in any reorganization. Listen
to Michael Rushmore, managing director of loan
research for BancAmerica Securities Inc., whose
parent company is the fourth-largest arranger of
leveraged loans: "The senior bank loan as an
asset class has provided a wonderful yield on a
risk-adjusted basis. We'll see more money
flowing in from institutions and retail investors."
Recent black eyes, such as Morgan Stanley's
inability to unload on investors $1.7 billion in
loans to troubled Sunbeam Corp., had more to
do with Sunbeam's problems than with the
leveraged-loan business.
And so the party rolls on. Michael Mona, a Las
Vegas contractor who is building his first casino,
is now hustling up several investors to back a $55
million to $60 million take-out loan for
construction of a gambling hall and restaurant
addition to an existing hotel and RV park. One of
these days the music will stop, and many of these
prime rate loans won't look very prime.
What happens if some of these new casino hotels
fail to earn enough to cover the interest? The
owners can probably work a restructuring deal,
but the buyers of the loans will take a haircut and
it will be scant comfort to them that junk
bondholders may take a more severe haircut.
Jason Ader, Bear, Stearns' respected gambling
analyst, shakes his head gloomily. "The ability
now for developers to access this high-yield
syndicated debt," he says, "has created more
rooms and more casino space in a market that
just doesn't need it." |
