Will the Banks Cut their Losses?
With a backlog of deals depending on bridge loans that banks are obligated to provide, investors are less willing to buy the junk bonds that are supposed to pay back the banks. As a result, this sort of junk bonds is selling at a discount. The banks will necessarily take a hit.
The Wall Street Journal is suggesting that the banks might do better if they can pay the private equity companies enough to compensate them for a 1% to 3% break up fee if the deal is not consummated. Will the PE companies go along with this?
Here is the article”
Cimilluca, Dana. 2007. “A Novel Theory: Break Up LBOs.” Wall Street Journal (28 July): p. B 4.
“A novel theory is circulating among some bankers about one way lenders could relieve the pressure on their balance sheets that the meltdown in the leveraged-loan market is creating. It holds that calling off some of the megabuyouts in the works, and paying the breakup fees that action would entail, could be cheaper than going forward with them. The breakup fee on an LBO deal typically runs from 1% to 3% of the total amount of debt banks need to sell to finance it. Loans and bonds for recent buyouts whose financing didn’t clear the market — and that banks got stuck with — are trading at as little as 91 cents on the dollar (U.S. Foodservice) or lower. That means the banks who arranged the financing for these deals already have taken a hit of as much as 10% on the loans.”
“Take the buyout of Texas utility TXU Corp., for example. Citigroup Inc., Goldman Sachs Group, Inc., J.P. Morgan Chase & Co., Morgan Stanley, Credit Suisse Group and Lehman Brothers Holdings Inc. agreed to provide as much as $37.4 billion of debt financing. The breakup fee that the buyers of TXU — Kohlberg Kravis Roberts & Co. and TPG — would be on the hook for if they walked away is $1 billion. That is considerably less than the credit losses the banks could face if the volatility the markets is experiencing now persists when the deal is funded.”
“Of course, it isn’t the banks’ decision whether to break up a deal. That rests with the private-equity firms. Still, big banks like Citigroup and J.P. Morgan aren’t without leverage. If the banks are forced to eat money-losing loans, that may take them out of the market for funding new deals for some time. So private-equity firms could be receptive to banks that approach them and offer to pay the breakup fees. (Another factor to consider, however, are the costs from lawsuits that would follow.)”