The debt market's summer swoon could hit Wall Street's high rollers where it counts.
Normally, by late July, bankers at
are busy jockeying for morning tee times. But with their firms stuck holding billions of dollars in loans they had hoped to sell, hard-hitting investment bankers suddenly have a more pressing concern: Will I get my bonus this year?
For years, the Wall Street banks have pulled down fat fees for financing
private equity's corporate buying spree. Those fees fed record bonus pots that lined the pockets of bankers who worked on the deals.
But now investors are balking at buying debt tied to Cerberus Capital Management's buyout of Chrysler, among other deals. That has left the Wall Street firms that backed the LBOs holding loans they meant to sell -- loans that are now eating a scary hole in their balance sheets and, potentially, in the profit numbers that figure in the bonus pool.
It remains to be seen if this is simply a natural resetting from a frothy market or, as one banker put it, a "classic unwinding of a liquidity boom that was false and based on financial alchemy."
Either way, the turnabout has left M&A pros fearful that even the outsized fees generated earlier in the year -- when the buyout boom was rocking and rolling, and Wall Street was reporting record profits -- might evaporate by bonus time, under the weight of lost fees and hefty write-offs.
Meanwhile, investors elsewhere are struggling to figure out how to restart the gravy train.
"Bankers are trying to figure out how to get CLOs done again," says one ex-senior banker who is now a manager at a distressed investment shop. CLOs are collateralized loan obligations -- debt created by Wall Street in hopes of dispersing the risk of commercial loan deals.
One senior banker told
that executives who fed off leveraged buyout activity led by the likes of
and Carlyle Group now are wringing their hands over the possibility jobs, let alone bonuses, might be go poof if the credit markets don't correct themselves soon.
The size of Wall Street's loan problem is sobering. On deck is more than $200 billion of bridge loans that banks have been offering up to private-equity shops to fund big LBO deals. Taking center stage of late has been Chrysler, which Cerberus is buying from
This week, investors declined to buy Chrysler's debt, leaving the bankers backing Cerberus' buy of Chrysler -- Citi and JPMorgan, first and foremost -- on the hook for about $10 billion. They hope in the next few weeks to hawk that debt to market participants.
But it's not just Chrysler that has Wall Street fretting. The on-deck list includes buyouts of
, along with many smaller deals.
It's not an issue of whether these deals will get done. They will. The big question is how much money individual banks will have to swallow to see them through.
But sources tell
that hedge fund investors, who have been the biggest buyers of leveraged loan paper, have been holding bankers over a barrel. The investors have taken to offering to purchase warehouse lines at between 80 and 85 cents on the dollar.
Other hedge fund managers and investors in collateralized loan obligations, smelling blood in the water, are sitting on the sidelines with the expectation prices will continue to fall. Of course, they could soon have their own liquidity worries if their prime brokers -- the same Wall Street banks now stuck with huge loans they can't sell -- run into trouble.
Up until the past several days, stress in the credit market has been in stark contrast to the stock market's push toward 14,000. What happened?
The problem starts with the terms at which many of these deals were underwritten during the buyout binge. Deterioration in the subprime market, which continues to up-end hedge funds and trip up big banks like Bear Stearns, has spotlighted underwriting quality and caused banks to ask for a bigger premium to hold risky paper.
Now the traditional buyers of risky paper are balking.
Loose credit terms such as so-called covenant-lite loans -- which contain few if any maintenance provisions that would allow an investor to ensure performance -- are returning to haunt banks. When the markets were hot, banks had no choice, one banker noted, because "if you don't extend credit on weak covenants, then you risk losing the business forever."
Whatever the case, at this point, credit worries appear to be having the spillover impact many observers portended would happen back in early spring when subprime slime oozed from lenders like New Century, which went into Chapter 11 in short order and is being liquidated.
Banks are locking up their balance sheets and consigning the balance sheet to lower market rates, said Punk Ziegel analyst Richard Bove, who notes that portions of deals such as Chrysler have been done for rates of 8.5%, which is far cheaper than the going rate for junk-rated debt of 9.17%.
Last week Bove downgraded brokers including
"Their loan losses are likely to increase," Bove said, speaking generally about banks holding bridge debt.
Goldman alone has some $72 billion in noninvestment grade debt on its books, according to its most recent filing with the
Securities and Exchange Commission
A Goldman spokesman declined to comment.
Last week, JPMorgan's CEO Jamie Dimon expressed concern about the environment that fostered the growth of bridge loans.
"I think equity bridges are a terrible idea," Dimon said on the bank's earnings conference call. "I think they're bad -- I think they're a bad financial policy. I don't think they're good for the banks."
Indeed, how bad of an idea it's been for JPMorgan, Goldman and others remains to be seen. Additional Chrysler debt is expected to hit the market in the next few weeks -- but into what market environment will this debt be sold?
Some banks, including Citi and JPMorgan, are hoping to offset potential losses via hedging, proprietary trading and/or overseas business. Other options include waiting out the market until things improve, and bridge loans and warehoused debt can be syndicated.
But what if things get worse?
"Why isn't this a meltdown?" asked one banker. "What's the bull case?"
The bull case is simple: Fundamentally, the overall economy has been strong, albeit slowing. The companies whose buyouts have been underwritten, save for iffy automotive industry plays like Cerberus' recent deals, are strong. Of course, that message has been mostly lost recently, most notably in Thursday's 2% marketwide plunge.
Either way, bankers' bonuses will tell the story at year-end.