Risky corporate loans are gradually piling up on the books of some of the world's largest banks.
Underwriters that agree to provide funds for buyouts are rarely forced to come up with the cash themselves, instead offloading the exposure to investors before deals close. Yet lenders including Barclays and Deutsche Bank have been left holding at least $1.5 billion of leveraged loans that they've struggled to sell over the past several months, according to people with knowledge of the matter.
The amount of hung debt is small relative to the almost $170 billion of leveraged loans issued in the U.S. and Europe this year to finance buyouts. Still, it's notable given the broad strength of credit markets at present, as opposed to the end of last year, when a sharp selloff left banks holding at least $3.6 billion of unsold debt. Market participants say the stalled deals pose little risk to the wider junk-loan market for now, though a marked uptick could constrain potential underwriting in the future.
"The mix of loans coming to market right now is very difficult" to absorb, said Steven Abrahams, head of strategy at Amherst Pierpont Securities, a broker dealer. "It's a very unusual story that leveraged loans and collateralized loan obligations are showing stress, even though the rest of the market is pretty benign, if not bullish."
Growing concern of an economic slowdown is prompting investors to steer clear of the riskiest issuers, those with excessive debt seen as vulnerable to a turn in the credit cycle.
Chunks of loans for at least five private equity deals are currently sitting on banks' books. Two of them -- for invoice processing company OSG Billing Services and kitchen-cabinet maker ACProducts -- were underwritten before last year's sell-off and have struggled to find buyers for many months now. Barclays, the sole underwriter on both, is still holding around half of each financing, the people said, asking not to be named discussing private transactions.
Others, like the debt sales for Apollo Global Management's buyout of photo-printing company Shutterfly and HGGC's take-private of fonts designer Monotype Imaging Holdings, were announced more recently. But they still failed to be fully syndicated as demand for riskier credits waned. A group of banks led by Barclays and Deutsche Bank was also left holding hundreds of millions of dollars of debt for Advent International's buyout of an Evonik Industries unit in July, the people said.
"The amounts in question are insignificant in the context of the wider market and insignificant to Deutsche Bank's debt-financing businesses," a spokesman for the German lender said in an emailed statement. A representative for Barclays declined to comment.
Investor concerns are still brewing.
Banks have struggled to sell an almost $3 billion cross-border debt package for Bain Capital's purchase of a majority stake in market-research firm Kantar. The underwriters have been forced to add a slew of concessions on pricing and documentation to the loan and bond deal to lure investors, while the deadline for commitments was extended twice.
Exit strategy
Offloading the hung loans could prove challenging for banks over the coming months. Worries over a potential downturn have reduced demand for lower-rated loans at risk of downgrades, especially from collateralized loan obligations, which face limits on the amount of debt rated in the weakest CCC tier that they can own.
"It is extreme bifurcation," said Jerry Cudzil, head of U.S. credit trading at TCW Group, who noted that sharp declines in the price of some leveraged loans in recent weeks have reduced investors' risk tolerance.
When stuck with unsold loans, banks often work with private equity sponsors to restructure the financing, typically with an injection of additional equity. If no solution is found, they're ultimately on the hook to provide the funds at the original terms.
To limit any member of the syndicate from offloading the debt at fire-sale prices, they often sign pacts that prevent one another from selling for a period of months below a certain threshold. In a best-case scenario, market sentiment or company fundamentals improve to an extent that the underwriters can attract buyers above the set level.
For some of the currently hung deals, that's a tall order for now, according to Cudzil.
"It is late cycle and there is growing risk of credit accidents," Cudzil said. "We kill so many loans in the early stages that we are not even going to look at a cabinet maker right now."
