Published by Uma Rajagopal
Posted on August 18, 2022
By Saeed Azhar, Anirban Sen and Davide Barbuscia
NEW YORK (Reuters) -Top U.S. and European banks are facing tougher times in the riskiest parts of the loan market.
The biggest U.S. lenders, including Bank of America and Citigroup, wrote down $1 billion in the second quarter on leveraged and bridge loans as rising interest rates made it tougher for banks to offload debt to investors and other lenders.
The pain has also spread across the Atlantic, after European lenders such as Deutsche Bank and Credit Suisse reported losses for such exposure.
Large U.S. and European banks are on track to lose $5 billion to $10 billion more in coming quarters on leveraged loans they have committed to underwrite, according to bankers and analysts.
Bank of America is among those most exposed to such writedowns because it is financing at least three large buyout deals at a time when the LBO market has come to a standstill, bankers and analysts said. Bank of America declined to comment.
In the leveraged loan market, banks typically make higher-risk loans to investors who want to purchase companies using the borrowed funds. As the market slowed, banks have responded with more stringent terms for new loans while struggling to distribute existing loans to other lenders and institutional investors. Buyers are seeking more favorable terms.
“If a bank wants to push a deal on to the market to investors, they’re going to have to bring it at a discount,” said Dan DeYoung, high yield and leveraged loan portfolio manager at fund manager Columbia Threadneedle.
Goldman Sachs, Bank of America and Barclays are among the top three bookrunners for leverage buyout financing for both leveraged loans and bonds since the fourth quarter of 2021 in the United States and Europe, according to data from Dealogic.
Goldman Sachs and Barclays declined to comment.
Banks typically sell the loans rather than holding them. They want to distribute about $80 billion to $100 billion of U.S. and European leveraged loans to other lenders and investors in September and October, a delay in the process due to market disruption, according to three bankers involved in the market. If they are sold at a discount, the underwriters would have to swallow some losses, the bankers said.
The market was disrupted by the Federal Reserve’s plan to tighten monetary policy to fight inflation, which sparked a sharp sell-off across fixed-income assets this year.
The yield spread on the ICE BofA U.S. High Yield Index, a commonly used benchmark for the junk bond market, rose to a two-year high of around 600 basis points in July. It has narrowed to 425 basis points, but is still up 120 bps since the beginning of the year.
“We all underestimated how big an issue inflation was, and how aggressively the Fed was going to have to move,” said a senior loan banker in New York.
“A number of the commitments that we wrote in the fourth quarter, and in January and early February, were quickly underwater because the rates were so aggressive,” he said.
The bigger deals include Bank of America-led financing for a $16.5 billion buyout of software company Citrix Systems Inc by affiliates of Elliott Management and Vista Equity Partners. The lender is also financing Apollo’s deal to buy Tenneco Inc which had an enterprise valuation of about $7.1 billion, including debt.
Bank of America is also among the banks backing billionaire Elon Musk’s $44 billion acquisition of Twitter Inc, a deal put on hold after Musk backed out. Twitter has sued to force him to complete the transaction.
For some, the market uncertainty merits a wait-and-see approach.
“The debt committed in the system needs to get placed and the equity investors … are being cautious, which is limiting LBO activity,” said Anu Aiyengar, global co-head of M&A at J.P. Morgan, referring to leveraged buyouts.
The price of existing loans on the S&P Leveraged Loan Index fell to a two-year low in July, according to Refinitiv data. While it has pared losses, the index’s decline this year reflects broader pressure on the debt markets and rising concerns that the Fed’s monetary tightening may pressure riskier borrowers. Two exchange-traded funds that track leveraged loans, the SPDR Blackstone Senior Loan ETF and the Invesco Senior Loan ETF, have dropped 4.9% and 3%, respectively, since the beginning of the year.
“Both the availability and cost of debt financing for sponsors has become a challenge in some situations, particularly in the syndicated loan markets,” said Steve Arcano, a global head of transactions practices for law firm Skadden, Arps, Slate, Meagher & Flom LLP, about the challenge faced by buyout firms.
The credit market is undergoing a wave of repricing after the Fed’s rate hikes, according to Minesh Patel, a senior director at S&P Global Ratings.
“The real crux of the issue is that the markets have shifted,” Patel said. Borrowing rates are becoming more expensive for companies with lower credit ratings, he said, citing an S&P study he co-authored.
Leveraged finance has been lucrative for large banks in recent years, so the expected losses will not be too alarming, said Marc Cooper, chief executive of Solomon Partners, a boutique investment bank in New York.
Large banks are “going to get crushed” in the latest bout of volatility, but “they’re big boys,” he said. “They’ll take their writeoffs and move on.”
(Reporting by Saeed Azhar, Anirban Sen and Davide Barbuscia in New York; Additional reporting by Chibuike Oguh and Lananh Nguyen; Editing by Richard Chang)
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