Even though the junk bond market has made an impressive rally since it got severely whacked in the commodities downdraft and the post-Fed rate-increase generalized selloff in January, the banks that are typically the first port of call for originating this type of debt are still suffering more than a bit of a hangover. From the Wall Street Journal:
Banks are increasingly turning down companies seeking financing to pay for debt-laden takeovers after the recent market rout left them saddled with debt from earlier deals.
Credit Suisse Group AG, Jefferies Group LLC and Wells Fargo & Co. are among the firms turning down new requests for financing—typically from low-rated companies—as they retreat from the lucrative but risky business of backing debt-heavy buyouts, people familiar with the matter say.
Banks guarantee the funding in these deals, hoping to then offload all or most of it to bond and loan investors. They promise to provide the money themselves if they can’t find others to buy the debt. But as markets swooned in the months since the summer, investors have lost their appetite for the riskiest securities, making them harder to sell.
Translation: these banks are still stuck with a lot of inventory that even now they can’t unload without taking losses. This not only means that tighter financing will result in less lofty multiples for transactions for typically highly-geared private equity transactions. Going-private deals also help support valuations for publicly-traded mid and small cap companies. Thus while the greater caution among lenders won’t have much if any S&P 500 multiples, since those companies are well above the size range of the amply-levered M&A deals, it could dampen stock prices in certain sectors of the market, particularly energy deals. On the one hand, even with the big gains in oil prices, financial buyers will be looking to swoop in and take advantage of distressed sellers. But the flip side is energy bankers have taken the biggest hits, and thus fresh loans would need to come from players that were largely on the sidelines in the shale lending frenzy.
The Journal shows that the impact isn’t just on the amount of financing being extended, but that some players are making a cyclican retrenchment by cutting staff:
With banks less willing to underwrite the most leveraged loans, the flow of new takeovers has slowed. U.S. mergers and acquisitions announced this year have fallen 21% from a year earlier to $229 billion, according to data from Dealogic. The pullback has made it hard for private-equity firms, which use a lot of debt in their takeovers, to get deals done. Those that are getting done, many are built to minimize junk debt, or debt rated below investment grade.New junk-bond sales are down 70% this year.
Banks including Wells Fargo and Jefferies have also started cutting the number of finance bankers in response…
Banks across Wall Street are becoming less willing to finance riskier takeovers. It is a turnaround from the past few years where record junk bond sales and soaring stock prices helped drive a mergers boom.
Regulators are playing a role, too. Federal bank regulators in general have cracked down on loans that would saddle companies with debt that exceeds six times their annual earnings.
The retreat is notable, because with trading businesses under pressure from crisis-era laws, advising on and financing acquisitions is one of the most profitable areas left to investment banks.
The article stresses that if conditions improve in the junk bond market, the banks will be more likely to open up their financing pipelines. However, it also cites a list of recent deals where banks are stuck with exposures they had expected to offload quickly, including the corporate deals, like Western Digital’s $19 billion SanDisk acquisition and Dell’s $67 billion purchase of EMC. It also gives examples of lending losses on recent private equity deals:
In November, a group including Bank of America Corp., Morgan Stanley, UBS Group AG and Jefferies struggled to sell about $5 billion of loans and bonds they had guaranteed for Carlyle Group LP’s $8 billion buyout of Symantec Corp.’s Veritas data-storage unit, according to people familiar with the matter. Investors balked at buying the debt after Veritas reported a sharp decline in quarterly earnings, the people said.
Carlyle ultimately renegotiated the deal in January at a price about $1 billion lower. Even so, the banks have yet to sell the loans and would face a loss of at least $250 million if they tried to unload the debt in current market conditions, bankers say.
A syndicate of banks led by Credit Suisse and Deutsche Bank AG has sold debt backing the purchase of Kraton Polymers at a loss of about $90 million over the past six weeks, the banks say. Discounted sales of loans for the buyout of department-store chain Belk Inc. have cost firms including Morgan Stanley, Bank of America, Credit Suisse and Jefferies about $100 million, they say.
While deal activity had fallen off in the fourth quarter, these examples of failed debt sales and resulting losses suggest that the damage done for those business units was significant. And of course, given that the earnings multiples for private equity deals last year exceeded the frenzied peak of the last cycle in 2007, and the Fed seems determined to keep tightening, even if that process winds up being attenuated, there’s no good reason to think the junk bond market will return to its rude health of 2015. Nouriel Roubini warned that 2016 was likely to feature more high volatility. Banks have gotten the wake-up call that risky assets like leveraged loans get whipsawed the most.