(Bloomberg) -- Wall Street banks were burned two years ago when they backed big corporate buyouts and ended up with tens of billions of dollars of “hung debt” they struggled to get rid of. Now they’re back for more.
Some investment bankers are ready to underwrite as much of 100% of the debt for European leveraged buyouts. One hotly contested deal, the €9.5 billion ($10.6 billion) financing for the buyout of Grifols SA, elicited an offer by a single bank for all the cash upfront, according to people with knowledge of the bids.
Terms on offer have been so generous at times that even private equity sponsors are asking whether banks are being too optimistic about the prospects for selling the debt on to other parties, a scenario that would drive up financing costs on future deals.
Uppermost in people’s memories are buyouts such as Elon Musk’s purchase of Twitter Inc., now X, which saddled a Morgan Stanley-led group with $12.5 billion of unwanted loans.
Undaunted, large banks are once again making aggressive moves.
“We are seeing intense competition among investment banks to lead on these material fee-event processes,” said Jeremy Duffy, partner and head of EMEA bank lending team at White & Case.
For banks rushing back into risky underwrites, it’s a calculated bet. The Federal Reserve is on the cusp of its first rate cut in more than four years, and on its coattails, the prospect of a rally for everything from leveraged loans to small cap stocks to emerging markets.
Aside from the single-bank offer to backstop Brookfield Asset Management’s potential take-private of Grifols, Goldman Sachs Group Inc. recently lined up all of the €350 million of financing to back Italian IT group Almaviva SpA’s purchase of US tech firm Iteris Inc.
Banks are also winning deals by negotiating ultra-low rates and higher leverage, meaning they agree to lend companies amounts that exceed their expected earnings by six times, or more. And they’re agreeing to much slimmer investor protections known as debt covenants, to give private equity firms more flexibility to add leverage or move assets around.
The stakes are high: Banker bonuses and jobs are linked to the number and size of deals they sign up.
So are the risks. Deals that are mispriced and left unsold aren’t just painful for banks. They look bad for private equity firms and their companies, and can drive investors away the next time they want to borrow.
In leveraged buyouts, PE firms line up financing from a group of banks at predetermined rates. The banks then parcel out the debt to other lenders, assuming the risk on their balance sheets for a short time before selling the loans to investors.
A breakdown in the lucrative leveraged loan machine left banks with $80 billion in “hung debt” when the Fed raised interest rates sharply. To unload the debt left on their balance sheets when demand collapsed, the world’s biggest banks had to swallow losses as high as 35%. A few hung loans are still hanging around: bankers for X continue to wait for the right moment to sell.
Banks bidding on a potential €7.5 billion financing package to support bids for Sanofi SA’s consumer health division are targeting pricing of 350 basis points over money-market benchmarks on the transaction, which is expected to be rated single B, according to people familiar with the matter.
For context, only three single B rated companies have priced euro-denominated loans at such a low margin this year, according to data compiled by Bloomberg. While banks also include a buffer, known as market flex, they are still leaving themselves little room to maneuver if the market sours.
High Leverage
The transaction will leave the Sanofi spin-off with leverage of around six times earnings, said the people familiar. And that deal could get more levered still: one of the remaining bidders, Clayton, Dubilier & Rice, is in discussions with banks around the possibility of using borrowed money to fund a part of the equity check for the deal, as reported by Bloomberg.
Deals like these represent the return of large-scale buyout financings that have been rare since the outbreak of war in Ukraine and two years of aggressive interest rate increases by global central banks.
Even so, chances to raise “jumbo” sized loans are far from plentiful. Banks recently lost out on the opportunity to provide at least €5 billion of financing to back the potential buyout of DB Schenker when a Danish rival acquired it in an all-cash transaction.
It’s a slightly different picture in the US, where leveraged loan prices are trading near a 22-month high and there are more big buyouts looking for financing.
“Jumbo deals are finally coming to market,” said Duffy at White & Case. “Not surprisingly, aggressive terms are being proposed for the right credits.”
--With assistance from Amedeo Goria.
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