Wall Street’s trillion-dollar financing machine is gummed up, creating a new hurdle for private equity titans who for years had easy access to credit.
Tens of billions of dollars worth of debt has been stuck on bank balance sheets left over from financings that had been struck before a sell-off rattled financial markets and an economic slowdown gripped the global economy.
The sharp fall in the value of corporate bonds and loans has banks such as Bank of America and Goldman Sachs stomaching large losses already on the financing packages they have not yet sold on to the investing public.
And bankers are reluctant to cut new deals for private equity groups before they are able to, a process that top executives said would likely be measured in quarters, not weeks or months. The terms they are offering are worse after this year’s losses in public markets, making any private equity buyout far more expensive to finance than a deal contemplated months ago.
“The traditional bank-financing and high-yield markets are effectively shut at the moment,” Kewsong Lee, chief executive of private equity giant Carlyle Group, told the Financial Times. “It’s why you’re seeing an even higher demand for private credit than ever before.”
It is a dramatic shift from the start of the year, when banks were finalising debt for megadeals such as Advent International and Permira’s buyout of McAfee, worth more than $14bn, and Hellman & Friedman and Bain Capital’s $17bn purchase of Athenahealth. Even better, they were getting calls from buyout giants such as Blackstone, KKR and Carlyle as they plotted a $25bn carve-out of Sandoz from Novartis and soon would have a surprise deal, Elon Musk’s $44bn takeover of Twitter, to finance.
But then interest rates shot higher. Investors began to bet that the Federal Reserve would need to dramatically tighten policy to curb inflation, a move that sent bond prices tumbling, including the debt banks were holding on their own balance sheets to fund deals. In quick succession, Russia’s invasion of Ukraine and lockdowns in China to slow the spread of Covid-19 hit markets, and investors began to prepare for recession.
Banks provide a critical function for the leveraged buyout industry, as buyout funds take companies private with a mixture of their investors’ own cash and a substantial portion of borrowed money that is raised from groups of lenders.
Wall Street lenders step in when a takeover is first struck, guaranteeing to provide loans, junk bonds and revolving credit facilities for the deal. But there is often a significant lag between when a deal is agreed and when it is consummated, as the companies must win shareholder backing if they are publicly traded and clear any regulatory hurdles.
The financing packages can be hugely lucrative but they carry sizeable risks if the market shifts from when banks and private equity groups initially set the terms of the debt packages. Those terms include the yield on the debt, covenants that will protect buyers and discounts banks can offer the funds and investors who will ultimately be the long-term holders of the bonds and loans.
If they are unable to sell the bonds at those terms, banks deepen the discounts, first eating into the profits they had hoped to earn on the deal. As the discounts rise, banks begin to pay for the difference out of their own pockets.
That nightmare scenario has played out for a group of 10 lenders providing $15bn of financing to fund Vista Equity Partners and Elliott Management’s $16.5bn takeover of software company Citrix. Banks including Bank of America, Credit Suisse and Goldman Sachs could lose $1bn or more on the deal, a staggering sum, according to people involved in the transaction.
The banks are attempting to rework the funding package to limit their losses, by shortening maturities on the debt and changing some of the debt to be held by the banks themselves, as they don’t believe they can find enough willing buyers.
Vista, Elliott, Bank of America, Credit Suisse and Goldman declined to comment.
In another stuck deal, a group of 16 banks has taken more than £200mn gross losses on selling debt from Clayton, Dubilier & Rice’s £10bn takeover of UK grocer Wm Morrison, the Financial Times reported this week.
The Citrix deal, along with the $5.4bn financing package for Apollo’s takeover of automotive supplier Tenneco, have both been postponed this month until after the US Labor Day holiday in September. Bankers involved in the deals are hoping the market will improve by then, curtailing some of their losses.
“There’s just a huge supply-demand imbalance out there,” said Brian Murphy, head of capital markets at First Eagle Alternative Credit. “People are very hesitant in the credit market . . . the economy is slowing and for lower-rated credits that can be a problem.”
JPMorgan Chase chief executive Jamie Dimon this month estimated that banks across Wall Street were on the hook for less than $100bn of financing packages, roughly a fifth of the level seen in 2007 on the precipice of the financial crisis. Several bankers told the Financial Times the figure was closer to $70bn-$80bn as banks used a recent bounce in the market to sell a handful of deals this week.
“The gumming-up of bank balance sheets is basically one of the key factors making the financing of new [takeovers] more difficult,” a top leveraged finance debt banker said. “When you have a problem like Citrix in your backlog, it’s really hard to put more piles on that. The way to dig yourself out is to stop digging the hole deeper.”
With banks stuck, private equity buyers are increasingly turning to direct lenders for financing.
Hellman & Friedman’s $10.2bn takeover of software firm Zendesk, announced in June, is being financed with over $4bn in private debt raised by a consortium of non-bank lenders led by Blackstone Credit.
Those involved in the deal say it would be hard to replicate such a large financing now.
“I don’t think there’s enough capacity to do a loan of that size if it were to come to market today,” said one person directly involved, who noted financing terms tightened significantly as the deal took shape.
“People are still launching new processes. I’m not exactly sure why, to be honest with you.”
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