Wall Street’s trillion-dollar funding machine is jammed, creating a new hurdle for private equity titans who for years had easy access to credit.
Tens of billions of dollars of debt remained stuck on banks’ balance sheets due to financings that had been completed before a sell-off shook financial markets and an economic slowdown gripped the global economy.
The sharp drop in the value of bonds and corporate loans means that banks such as Bank of America and Goldman Sachs are already suffering large losses on financial packages that they have not yet sold to the investing public.
And bankers are reluctant to close new deals for private equity groups before they can, a process 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 the public markets, making any private equity buyout far more expensive to fund than a deal contemplated months ago.
“Traditional bank and high-yield funding markets are effectively closed 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.”
This is a stark change from earlier this year, when banks were finalizing debt for mega deals such as McAfee’s takeover by Advent International and Permira, worth more than $14 billion. , and the purchase of Athenahealth by Hellman & Friedman and Bain Capital for $17 billion. Even better, they were getting calls from takeover giants like Blackstone, KKR and Carlyle as they planned a $25 billion divestment of Sandoz to Novartis and would soon have a surprise deal, Elon Musk’s takeover of Twitter for 44 billions of dollars, to be financed.
But then interest rates skyrocketed. Investors began betting that the Federal Reserve would have to dramatically tighten policy to rein in inflation, a move that sent bond prices plummeting, including debt banks holding their own balance sheets to fund 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 to prepare for recession.
Banks perform a critical function for the leveraged buyout industry, as buyout funds privatize companies with a mixture of their investors’ money and a substantial portion of the borrowed money that is raised from groups of lenders.
Wall Street lenders step in when a takeover first closes, guaranteeing to provide loans, junk bonds and revolving credit facilities for the deal. But there’s often a significant lag between when a deal is struck and when it’s done, as companies have to win shareholder support if they go public and overcome any regulatory hurdles.
Financial packages can be extremely lucrative, but they carry significant risks if the market changes from when banks and private equity groups initially set the terms for debt packages. These terms include the yield on debt, covenants that will protect buyers, and discounts that banks can offer funds and investors who will ultimately be the long-term holders of the bonds and loans.
If they are unable to sell the bonds on these terms, the banks deepen the discounts, starting by chipping away at the profit they had hoped to make on the transaction. As rebates increase, banks begin to pay the difference out of pocket.
This nightmare scenario unfolded for a group of 10 lenders providing $15 billion in funding to fund Vista Equity Partners and Elliott Management’s $16.5 billion buyout of software company Citrix. Banks such as Bank of America, Credit Suisse and Goldman Sachs could lose $1 billion or more on the deal, a staggering sum, according to those involved in the deal.
Banks are trying to rework the financial package to limit their losses, by shortening debt maturities and modifying some of the debt held by the banks themselves, because they do not think they can 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 suffered gross losses of more than £200m on the sale of debt from the £10bn takeover by Clayton, Dubilier & Rice of the British grocer Wm Morrison, the Financial Times reported this week.
The Citrix deal, as well as the $5.4 billion financial package for Apollo’s takeover of auto supplier Tenneco, were both delayed until after the Labor Day holiday in the United States this month. in September. The bankers involved in the deals are hoping the market will improve by then, paring some of their losses.
“There’s just 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 down and for lower rated credits this can be a problem.
JPMorgan Chase chief executive Jamie Dimon estimated this month that Wall Street banks were responsible for less than $100 billion in funding, about a fifth of the level seen in 2007 on the brink of the financial crisis. Several bankers told the Financial Times the figure was closer to $70 billion to $80 billion, as banks took advantage of a recent market rebound to sell a handful of deals this week.
“The erasure of bank balance sheets is fundamentally one of the key factors making the financing of new [takeovers] harder,” said a leveraged financial debt banker. “When you have an issue like Citrix in your backlog, it’s really hard to put more stacks on it. The way to dig yourself out is to stop digging the hole any deeper.
With banks in lockdown, private equity buyers are increasingly turning to direct lenders for funding.
The $10.2 billion takeover of software company Zendesk by Hellman & Friedman, announced in June, is funded 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 be difficult to replicate such large funding now.
“I don’t think there’s enough capacity to make a loan of this size if it were to come to market today,” said one person directly involved, who noted that financing terms have tightened. considerably tightened as the agreement took shape.
“People are still starting new processes. I don’t know exactly why, to be honest with you.