Jun 23, 2022
Wall Street Faces Billion-Dollar Losses on Sinking Buyout Debt
(Bloomberg) -- Investment bankers in the US and Europe are bracing for potentially billions of dollars in total losses on big-ticket leveraged buyouts as they struggle to offload risky corporate debt that’s plunging in value amid a sweeping market selloff.
The biggest hit, which could amount to about $1 billion, may come from the take-private of Citrix Systems Inc., which a group of lenders led by Bank of America Corp., Credit Suisse Group AG and Goldman Sachs Group Inc. signed in January, according to people with knowledge of the deals and the terms at which banks underwrote them.
Each of the three lead banks could face losses in excess of $100 million, said the people, who asked not to be identified when discussing private transactions.
With the Federal Reserve rushing to hike interest rates at the fastest pace in decades, credit risk premiums are surging far beyond levels banks had negotiated with private equity firms during the halcyon days of cheap money.
Underwriters on both sides of the Atlantic are now sitting on an estimated $80 billion of commitments backing leveraged buyouts that will be difficult to sell in a market for junk debt that is effectively frozen. While that’s a modest undertaking compared to the more than $200 billion stockpile heading into the 2008 crisis, the worry is that writedowns will grow as rates rise, acting as a drag on earnings.
“The difference this time is that the Fed is not going to bail anyone out,” said Richard Farley, a partner at Kramer Levin Naftalis & Frankel LLP, who advises banks and direct lenders on buyout financings.
Last week Deutsche Bank AG showed its peers the scale of the problem as it sold high-yield bonds backing the buyout of packaging firm Intertape Polymer Group Inc. at just 82 cents on the dollar, one of the steepest discounts on a new junk-bond issue in two decades.
Ditto for Credit Suisse. It finalized the sale this week of an offering backing Lone Star Funds’ acquisition of chemicals distribution company Manuchar NV at the largest discount in a decade for the European market: 86 cents on the euro.
Discounts may may not need to be as steep for companies that are perceived as less sensitive to the economic cycle and any reversal in market sentiment may ultimately lessen the pain for banks. But barring a surprise shift in credit conditions, losses could pile up quickly on deals that were underwritten at very favorable terms for borrowers, as in the case of Citrix.
Banks agreed to a maximum rate of 9% on $4 billion of unsecured bonds backing that deal. With the average yield on risky CCC securities now approaching 13%, lenders may need to sell the debt at a discount well below 90 cents to attract interest from buyers, potentially leading to hundreds of millions of dollars of losses on that tranche alone, according to the people and per Bloomberg calculations.
Representatives for Bank of America, Credit Suisse and Goldman Sachs declined to comment.
In the UK take-private deal of Wm Morrison Supermarkets Plc, a group of underwriters led by Goldman Sachs has already racked up losses in excess of 125 million pounds ($153 million) by offloading chunks of the financing at steep discounts. The pain is set to deepen as lenders prepare to sell a portion of the 2.2 billion pounds of loans still sitting on their books at a discount in the low-to-mid 90s, people with knowledge of that deal said.
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Other challenging transactions include Standard General’s buyout of media company Tegna Inc., Apollo Global Management Inc.’s acquisition of auto parts maker Tenneco Inc., and Clayton, Dubilier & Rice’s takeover of metal roofing company Cornerstone Building Brands Inc., according to the people. Banks started informally sounding out investors on the Cornerstone financing a few weeks ago but the transaction is yet to emerge.
“Banks agreed to finance deals months ago and we’ve had a massive shift in expectations,” said Nichole Hammond, a senior portfolio manager at Angel Oak Capital Advisors. “The uncertain economic backdrop is causing investors to be much more selective and they want to be paid more for the risks they are taking.”
The scale of the problem will become clearer when banks release second-quarter earnings. Several in Europe have opted to keep lending commitments on their balance sheets in order to avoid crystallizing losses while hoping that markets could turn around, according to the people.
That’s occurred in the US as well. A group of banks led by Bank of America ultimately self-funded a $615 million loan supporting Bain Capital’s buyout of VXI Global Solutions, after failing to place the debt with institutional investors.
Earlier in the year, sponsors were able to turn to cash-rich private lenders to place the riskiest piece of their buyout financings. But it is unclear how much appetite shadow lenders -- and more opportunistic ones like hedge funds -- will have in the coming months.
Bankers are required to mark commitments at levels where they think the debt could clear the market even if they haven’t sold it yet. In the first quarter of 2020, for example, JPMorgan Chase & Co. and Credit Suisse each took hundreds of millions of writedowns related to acquisition deals that they had agreed to finance before a pandemic-induced freeze in credit markets.
They were able to recoup most of those losses thanks to the Fed’s historic intervention to support the economy and the flow of credit. Today, as central bankers battle the highest inflation in four decades, market practitioners say it is more difficult to envisage a bullish scenario where debt values recover quickly.
“A lot of smart people think it’s going to get worse,” said Farley at Kramer Levin.
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