Ohh, the plot thickens. Investment banks are choking on unsold inventory of LBO loans that appears destined to continue to fall in value. These deals are already underwater and expected to hear further south. The interest payments float off short-term interest rates. so the widely anticipated Fed rate cuts will make them even less attractive.
Part of why the firms are now in this mess is that they had entered into funding commitments prior to the acute phase of the credit crunch in August. Their obligations were clear, so it was well-nigh impossible to weasel out of them, and investment banks were also concerned about their reputations.
Image is a luxury of the wealthy, and crass commercial considerations have now taken precedence. Attorneys are now advising the big securities firms to abandon these deals, since any fees they would pay would be less than the losses they would sustain by moving ahead. And if all firms take this posture, there won’t be any stigma attached.
The Financial Times article on this development quotes a lawyer who says this move would mean 500 to 1000 points off the Dow. He has clearly drunk a bit too much of his clients’ Kool-Aid. While this is a negative for stocks, there has already been a big slowdown in buyout activity since the summer and some experts forecast a prolonged period of adjustment. An incremental change won’t have that big an impact.
From the Financial Times:
Leading banks are being advised that it would be cheaper to walk away from big buy-out deals than incur further losses on their funding commitments… legal advisers argue that the break-up fees banks would owe in such cases would be far lower than the write-downs they would have to make on their loans…
However, the chances of banks abandoning buy-out deals – such as those for Clear Channel Communications, the radio station owner and outdoor advertising company, and BCE, the Canada-based telecoms group – are growing as the market prices for the leveraged loans used in such transactions continue to fall….
Already, it is understood that one bank has marked down its share of the loan used in the Clear Channel buy-out to 85 cents on the dollar.
By contrast, lawyers are telling the banks that if they walk away from deals, their biggest liability would be equivalent to the so-called reverse break-up fee that private equity firms pay target companies when deals fail to close. These fees usually amount to about 2 per cent of the total value of a deal, or about $500m in a large buy-out.
Lawyers say there could be other costs for the banks, such as covering the expenses buy-out firms incur while doing their homework on bids.
Further, they do not rule out the possibility that banks could have to pay greater damages in litigation.
What is sure is that banks are giving greater thought to dropping out of deals. “We are already there in terms of the economic pain,” said the head of debt capital markets at one major Wall Street firm. “Banks sitting on $30bn of debt for one deal are looking at $4.5bn of losses. That is enough to play hardball.”