Banks' Long LBO Nightmare

The credit crunch vexing big banks may not play itself out till the middle of next year, according to a recent report issued by Fitch Ratings.

The could mean more bad news for investors in hard-hit financial stocks like Citigroup (C), JPMorgan (JPM), Lehman Brothers (LEH) and Goldman Sachs (GS).

Fitch identifies some $350 billion in pending leveraged buyout debt weighing down bank balance sheets, along with $150 billion in completed deals that still need to be syndicated.

The rating agency sees the credit turmoil undercutting bank earnings in the short term as they try to shop loans at deeply discounted prices.

"Such sales may come at the expense of material earnings hits that will eliminate or greatly reduce earnings in a given quarter," the report states.

James Moss, managing director at Fitch covering North American financial institutions, says it can be hard to figure where losses may turn up on bank balance sheets, given all the accounting flexibility available. But he noted that bank observers must pay attention to areas such as trading assets and loans held for sale.

Banks that have been stuck with big-ticket loans include Citi, JPMorgan, Bank of America (BAC) and Lehman. Together they have $128 billion in leveraged loans on deck in the top 20 largest buyout deals.

Next week, Lehman could offer some insight on how much pain these institutions will face. The firm is due to report third-quarter earnings Tuesday morning. Other big names due to report in coming weeks include Morgan Stanley (MS), Bear Stearns (BSC) and Goldman.

No matter how the earnings come in, Wall Street is looking at some drawn-out negotiations, re-jiggered financings and even scratched deals over the next several months.

Take the intense discussions between private-equity firm Kohlberg Kravis Roberts and its bankers, which are aiming to obtain concessions on the $26 billion buyout of First Data(FDC).

Reports suggests that that deal may be dragging along for several weeks as the parties attempt to work out terms that will see the debt sold to debt buyers, which have been reluctant because of its loose underwriting terms.

On the brighter side, financials analyst Moss says that Fitch believes that the crisis the market is facing has more to do with liquidity than the underlying credits being financed. The agency's expectation is that, even in the most extreme scenario, banks will be able to weather the credit storm.

>To order reprints of this article, click here: Reprints