Financials to Suffer From Lax LBO Underwriting - Barron's

by: Judy Weil

Annotated article summary from this weekend's Barron's. Receive all our Barron's summaries by signing up here:

For Banks, a $300 Billion Hangover by Jacqueline Doherty

Summary: In the race to grab more underwriting profits from the leveraged buyout craze, investment banks like Citigroup (NYSE:C), JP Morgan (NYSE:JPM), Goldman Sachs (NYSE:GS) and Merrill Lynch (MER) provided $300 billion of LBO debt at low interest rates and disadvantageous terms. They expected to sell the debt onward to investors, but now no one's buying. The plum financing conditions that private equity dictated pre-credit crunch discouraged exit clauses despite: 1) Harder to prove company valuation declines that could alter contracts. 2) Debt covenants that allow banks a meager 0.25% coupon change in declining markets. Spreads have already widened to 1-2%. 3) Loan spending terms that favor companies over banks 4) The significant equity commitments banks gave alongside loans. For example, Citibank, JPM and Morgan Stanley (NYSE:MS) must provide $500 million in equity for the KKR/ TXU deal. Deteriorating credit markets are forcing banks to either sell devalued debt at mark-to-market losses of 10-12%-- so far-- or hold on and wait for markets to improve. This would tie up capital and losses could deepen. Some wish banks would just pay the 'cheaper' breakup fees and walk away, but that would invite lawsuits. Because underwriting is often a group effort, Barron's says many banks and investors could face big writeoffs.

Related Links: The Fed's Discount Marketing: Window-Dressing for More Bad NewsHow Would Less Buyout Funding Affect Brokers?