Posted on 03/25/2008 4:31:09 AM PDT by TigerLikesRooster
Bankers watch for falling knives as sponsors feel pain
James Mawson
25 Mar 2008
Investment banks that have found private equity a lucrative business over the past few years are about to receive a double blow: falling fees from financial sponsors this year as well as writedowns of private equity assets held on their books.
The problem is most visible at the largest banks that targeted the biggest private equity firms as clients. Banks specialising in the mid-market are more confident of their ability to withstand the growing capital markets storm.
A Financial News survey of 20 of the largest investment banks with dedicated financial sponsor coverage teams found that pain was already being felt from falling knives in varying degrees of acuity.
One head of financial sponsors at a global investment bank said: “Sponsor coverage and leveraged finance is at the eye of the storm and will be the weakest element of investment banks whereas previously those departments made up 50% to 60% of the banks’ revenues.”
He feared revenues would more than halve from last year, which would represent a significant fall: data providers Dealogic and Thomson Financial had broadly similar figures for fees paid by financial sponsors to investment banks last year at $15.6bn (€9.9bn) and $15.1bn respectively.
The gloomy prognosis was echoed at rival banks. One said: “Halved volume is probably a generous estimate. I think the fee pool this year will shrink enormously, judging from the run rate of expected deals. An 80% cut looks acutely possible.”
A co-head of financial sponsors coverage at a European bank said: “If we do 60% of our fees last year we will have done very well, assuming there is not a complete meltdown after Bear Stearns’ sale.” Another said: “Deal volumes halving in 2008 sounds potentially optimistic to me.”
A global head of sponsors summed up: “It is sadly true that 2008 will be brutally ugly in sponsor land. Sponsor revenues will fall correspondingly with activity levels.”
Last year there were $796bn worth of buyouts compared to $729.9bn in 2006, according to Dealogic, while rival data provider mergermarket put the figure at $880.2bn, a near 10% rise from the year before. However, since July’s liquidity crunch started, there has been a dramatic drop in activity and fees as the pipeline of planned and agreed deals has fallen.
In the final three months of last year, investment bank revenues from financial sponsors dropped to $2.7bn, according to Dealogic – the lowest quarterly figure since the end of the dotcom crash in the fourth quarter of 2003. The pace has slowed further since then.
Mergermarket said in the current calendar year to March 5 there had been $35.4bn worth of buyouts around the world.
Half were from European deals, including Kohlberg Kravis Roberts’ £1.1bn (€1.4bn) buyout of outsourcing technology company Northgate Information Solutions, which completed at the start of the month.
According to bank results posted last week, the private equity operations at Goldman Sachs and Lehman Brothers have seen a cut of more than $2bn each from their revenues in their first quarter results compared to the same period the year before.
Goldman Sachs did not break out the writedown for its portfolio of leveraged loans that often back private equity deals.
However, Lehman Brothers said there was a $700m gross mark-to-market adjustment for acquisition finance facilities in the first quarter to take its gross balance at the end of February to $28.7bn. This balance was down from $35.8bn at November 30 as it sold the debt from its books.
Other banks are also facing writedowns on their debt portfolios. In a separate research report, Lehman said the average bank had written down by 5% the value of its aggregate $241.1bn leveraged loans while the total debt exposure could require another $161.1bn of cuts.
Banks are keen to broaden their coverage to new regions. A co-head of financial sponsors said it was looking for new clients in eastern Europe and the Middle East.
Scott Phillips, head of Société Générale’s financial sponsor coverage group, said that as well as those areas, the bank had set up a team in Australia for leveraged finance and to help its Asian operation.
Bankers were also pitching the ability to help private equity firms with minority stake purchases as well as enabling them to buy portfolio company debt.
Buying minority stakes in public companies, which came to prominence in Europe with Blackstone Group’s purchase of 4.5% of German phone operator Deutsche Telekom, often requires the use of structured finance and derivatives bankers.
But one global head of financial sponsors at an investment bank said there was more talk over these two areas than investment because of the complexity of such deals.
And a peer said: “No amount of mid-market push or other initiatives can mitigate the fact that you cannot buck the market.”
This is already feeding into staffing. One head said: “It is a game of chicken as you do not want to cut too quickly or too much but each quarter that revenues are lower than previous years increases the departures.”
As a result, one head said it was moving staff to cover sovereign wealth funds and other areas instead of bulking up coverage of the largest buyout firms.
• Mid-market is new battleground as rivals compete for share
To compensate for the poor outlook, banks are trying to develop other markets or steal market share from capital-constrained rivals. The main area of competition is in the mid-market since only deals below €3bn can now be financed.
Matteo Canonaco, head of financial sponsors at HSBC, said: “The mid-market is all there is at the moment as no bank will be part of an underwriting debt syndicate exceeding $1.5bn to $2bn and even then you probably need five to six banks. Balance-sheet banks like us should be able to capture market share, implying a double whammy for the investment banks who are not underwriting debt at this stage.”
Christian Hess, co-head of financial sponsors at UBS, said: “We think we can continue to gain market share in these testing times as the mid-market has been part of our strategy for five years.”
David Silver, managing director of investment banking at Robert W Baird, said he was seeing a number of business opportunities in Europe.
Ping!
That ENRON video comes to mind.
LEH is goin’ down. They were down 4+% yd in a buying panic, and they’re down another 3% already today in a flat market. They’re another Bear Stearns — one fine day within the next couple of weeks we’ll wake up and they’ll be dead.
Couldn’t happen to a nicer bunch. The sad part is that the Fed can be counted on to cobble together some sort of taxpayer guaranteed bailout if things head south for any of the major investment banks.
So let’s understand how this works. Your company makes a series of very risky investments and if those investments pan out, your company gets to keep the upside gain. But if it heads south, you can count on the Fed galloping to the rescue. And all the while, you draw an overly generous compensation package. Where do I sign up for this sweetheart deal?
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