Wall Street’s trillion-dollar financing machine has gone under, creating a new hurdle for private equity titans who for years had easy access to credit.
Tens of billions of dollars worth of debt have been stuck on bank balance sheets left over from financings that were secured before a selloff rocked financial markets and an economic slowdown gripped the global economy.
The sharp fall in the value of corporate bonds and loans means that banks such as Bank of America and Goldman Sachs are already taking big losses on financing packages that they have not yet sold to the investing public.
And bankers are reluctant to cut new deals for private equity groups before they can, a process that senior 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 much more expensive to finance than a deal contemplated months ago.
“Traditional bank and high-yield funding markets are effectively shut down at the moment,” Kewsong Lee, chief executive of private equity giant Carlyle Group, told the Financial Times. “That’s why you’re seeing even higher demand for private credit than ever before.”
That’s a dramatic shift from earlier this year, when banks were ending debt for megadeals like Advent International and Permira’s more than $14 billion purchase of McAfee and the of Athenahealth for $17 billion from Hellman & Friedman and Bain Capital. Even better, they were getting calls from buyout giants like Blackstone, KKR and Carlyle as they planned a $25 billion takeover of Novartis’ Sandoz and would soon have a surprise deal, Elon Musk’s $44 billion acquisition of Twitter of dollars, to finance.
But then interest rates went up. Investors began betting that the Federal Reserve would have to tighten policy dramatically to curb inflation, a move that sent bond prices tumbling, including by debt-ridden banks holding onto their own balance sheets to finance the 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 preparing for recession.
Banks provide a critical function for the leveraged buyout industry, as buyout funds take companies private with a mix of their investors’ own cash and a substantial portion of borrowed money raised from groups of lenders.
Wall Street lenders step in when a takeover is first made, securing 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 companies must win shareholder support if they go public and clear any regulatory hurdles.
Financing packages can be very lucrative, but they carry considerable risk if the market changes from when banks and private equity groups initially set the terms of the debt packages. These terms include the yield on the debt, covenants that will protect buyers and discounts that banks can offer to the funds and investors who will ultimately be the long-term holders of the bonds and loans.
If they can’t sell the bonds on those terms, the banks dig deeper into the discounts, first eating up the profits they expected to make from the deal. As the discounts increase, the banks start paying the difference out of their pockets.
That nightmare scenario has played out for a group of 10 lenders providing $15 billion in financing to finance Vista Equity Partners and Elliott Management’s $16.5 billion acquisition of software company Citrix. Banks such as Bank of America, Credit Suisse and Goldman Sachs could lose $1 billion or more in the deal, a staggering sum, according to people involved in the transaction.
Banks are trying to rework the financing package to limit their losses, shortening debt maturities and shifting some of the debt to be held by the banks themselves, as they believe they cannot find enough willing buyers.
Vista, Elliott, Bank of America, Credit Suisse and Goldman declined to comment.
In another stalled deal, a group of 16 banks has taken gross losses of more than 200 million pounds by selling debt from the 10 billion pound acquisition of Clayton, Dubilier & Rice from British grocer Wm Morrison, the Financial reported times this week
The Citrix deal, along with the $5.4 billion financing package for Apollo’s acquisition of auto supplier Tenneco, were delayed this month until after the US Labor Day holiday in September Bankers involved in the deals hope the market will improve by then, paring some of their losses.
“There is a huge imbalance between supply and demand,” 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 credit that can be a problem.”
JPMorgan Chase Chief Executive Jamie Dimon estimated this month that Wall Street banks were on the hook for less than $100 billion in financing packages, about 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 $70-80 billion, as banks used a recent bounce in the market to sell a handful of deals this week.
“The swelling of bank balance sheets is basically one of the key factors in the financing of new [takeovers] harder,” said one leveraged finance debt banker. “When you have a problem like Citrix in your backlog, it’s very difficult to put more stacks on it. The way to dig yourself out is to stop digging the hole deeper.”
With banks stagnating, private equity buyers are increasingly turning to direct lenders for financing.
Hellman & Friedman’s $10.2 billion acquisition of software company Zendeskannounced in June, is financed by more than $4 billion in private debt raised by a consortium of non-bank lenders led by Blackstone Credit.
Those involved in the deal say it would now be difficult to replicate such a large funding.
“I don’t think there would be enough capacity to do a loan of this size if it came to market today,” said one person directly involved, noting that financing conditions tightened significantly as the deal took shape
“People are still launching new processes. I don’t know exactly why, to be honest with you.