The Year in Review: #2. Deal Breaker

At the dawn of 2007 few Americans knew anything about subprime mortgages and the arcane financial instruments they funded. By August the words "credit crunch" dominated conversations from living rooms to boardrooms.

A quick recap: Financial institutions bundled subprime mortgages---those issued to the least creditworthy borrowers--into securities sold worldwide. As housing prices went south and interest rates rose, those borrowers started defaulting, deflating the value of the mortgage-backed securities. Lenders and investors abruptly turned cautious about all transactions. They demanded higher returns to lend money or buy assets, or halted activity altogether. Credit dried up. That not only burst the real estate bubble; it also chilled the leveraged buyout boom.

Suddenly private equity buyers insisted on renegotiating large deals. Home Depot, for example, had to lower the price of its wholesale supply unit from $10.3 billion to $8.5 billion in August because private equity firms had to pay a higher interest rate for money borrowed for the deal.

While other big transactions either tanked or were re-priced, middle market and smaller deals moved forward as still-liquid private equity funds, cash-rich corporations and foreign investors stepped into the breach.

"There is still a lot of cash in private equity funds, and strategic buyers in some industries are seeing more opportunities to make deals at realistic prices, where before private equity was bidding prices up too high for them," says Michael Conlon, partner-in-charge of Fulbright & Jaworski's Houston office.

While that's good news for dealmakers, dark clouds still loom as major financial institutions report massive losses. Conlon also notes that an economic slowdown could result in a surge in bankruptcies in companies acquired at inflated prices during the leveraged buyout boom.

Senior Editor

Mary Swanton

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