John Slater's  Instablog

Since the collapse of the syndicated loan markets in August 2007, the private equity M&A market has gone from red hot to stone cold at the high end and luke warm in the middle market.  The primary cause of this collapse is not lack of equity; at the beginning of the year PE firms had close to $200 Billion of dry powder.  The issue holding back the M&A market worldwide has been the lack of leverage for new deals. 

Recently we have been presented with the spectacle of a high flying banker in deep financial trouble proclaiming that he and his organization have been wrongly singled out for reprisal by the Federal government.  The charges are clear.  His bank aggressively sought deposits from around the world to fund a portfolio of outrageously bad investments, leading to the bank’s insolvency.  The bank funded high paid executives’ lavish lifestyles, including Caribbean junkets, sports sponsorships, a fleet of private jets and outsized bonuses unrelated to actual performance.  Insider loans were made to bail out the personal financial problems of those in control.  Yet that banker has the gall to blame overzealous government actions for his problems.

This morning the New York Times reported that the Treasury is planning to convert TARP holdings of preferred stock into common equity at a number of banks. As we previously raised, the real issue is whether and why the Treasury is committed to protect the bondholders of the big banks. There is a great deal of capital in the banking system in the form of unsecured debt.  In a normal world, when a company goes broke, some or all of the debtholders’ interests will ultimately be converted to equity capital either in bankruptcy or in an out of court restructure.  The current issue of The Institutional Risk Analyst makes a very interesting proposal for conversion of Citibank debt into equity, which would address the capitalization issue once and for all.  It’s time the Treasury explains in clear English why they are electing to further commit taxpayer funds to bailing out the big banks’ bondholders rather than demanding that they contribute to solving the capital deficiency problems.

Disclosure: No Positions

Seven months ago (Monday September 15, 2008) we learned of the failure of Lehman Brothers and soon thereafter the sale of Merrill Lynch and the bailout of AIG.  These events were the culmination of a series of market shocks that had started with the demise of the sub-prime loan market, had accelerated with the collapse of the leveraged loan market starting in August 2007 and had included the takeover of Bear Stearns in March 2008.  But September 15, 2008 is the current era’s equivalent of 1929’s Black Monday.

The old saw goes “a banker is someone who lends you an umbrella when the sun is shining and asks for it back when it begins to rain.” It’s certainly raining now and we are working with a number of clients who are in danger of losing their umbrellas. My partners Stan Cutter and Mike Zook have recently published a very insightful article which addresses some of the issues companies are facing with their banks. One of their key points: you may be in trouble even if your company is performing well, if your lender is in trouble or has recently been sold. We’ve reproduced the article in its entirety below:

Our previous post raised the question of just how much risk is being assumed by the U. S. Treasury with its apparent implied guaranty of the unsecured obligations of the major financial institutions.  We asked whether the $188 Trillion (notional amount) of derivatives transactions on the books of four major banks (J. P. Morgan Chase, Bank of America, Citibank and Goldman Sachs) could potentially pose risks not fully understood by the banks or their regulators.