Leveraged Buyout Credit Can Leave Lasting Scars | Opinion

Leveraged finance bankers get headache after party from hell. Bank of America, JP Morgan, Goldman Sachs, Morgan Stanley, Credit Suisse and Deutsche Bank collectively posted a second-quarter loss of $1.5 billion on loans they made to heavily indebted companies. The coup adds to the arguments in favor of job cuts.

Bank leveraged finance offices provide short-term loans to finance acquisitions, typically for a 1% to 2% fee, which they sell to investors such as pension funds after a few months. The problem begins when markets crash before banks transfer risk, forcing them to write off loans in anticipation of selling them at a loss.

That has happened this year, when rising rates and recession fears have caused investors to shy away from risky debt. The average price of US high yield bonds fell as much as 16% between January and early July, according to the ICE BofA US High Yield Index. Among the most troublesome recent deals is the purchase of British supermarkets Wm Morrison (Morrisons), backed by Goldman Sachs and others. If a court forces Elon Musk to buy Twitter, banks led by Morgan Stanley could take a hit as they unload the $13 billion financing. The $1.5bn of losses incurred at just six big banks is equivalent to more than half of the industry-wide fees this year for arranging leveraged buyouts, according to data from Dealogic.

The good news is that the markets are recovering. The ICE BofA index itself, for example, is up 7% since the end of June. That will make it easier for banks to sell the $80 billion of loans that were stuck on their books at the end of July, according to a senior banker’s estimate.

But the outlook remains bleak. With interest rates rising and the world headed into recession, banks are unlikely to recoup all losses. The lenders behind the $15 billion debt package to buy Citrix Systems may end up holding some of the loan in their portfolio for a while to avoid flooding the market, according to a source familiar with the deal. That consumes valuable capital.

In addition, the boom years of purchases, fueled by cheap debt, may be over. investors of private equity, like pension funds, are reducing their exposure to this asset class at a record pace. And private lenders are crowding out the banks. Banks took in $7.8 billion last year from arranging buyouts, which was 50% more than the average from 2017 to 2019, according to Dealogic. The likely reduction in fees in the future, and the memory of this year’s losses, will make it difficult for banks to justify maintaining the same level of staff.

The authors are columnists for Reuters Breakingviews. The opinions are yours. The translation, by Carlos Gómez Abajo, is the responsibility of Five days

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