Wall St braced for buy-out loans pain
By Peter Thal Larsen in London and Francesco Guerrera
Wall Street investment banks are poised for further pain from loans to private equity groups when they start reporting first-quarter results this week.
Goldman Sachs and Morgan Stanley are forecast to write off at least an extra $1bn (£493m) on their portfolios of loans for leveraged buy-outs, with Lehman Brothers, another provider of buy-out financing, also expected to suffer a big writedown.
Deutsche Bank analysts expect US investment firms and commercial banks to report more than $9bn in additional losses on leveraged loans in the first half of this year.
The writedowns will add to pressure from investors and auditors for other lenders to follow suit. With more than $200bn of loans committed or stuck on banks’ balance sheets, the hit to profits could be substantial.
However, some big commercial banks may have an advantage over Wall Street securities houses when it comes to limiting the pain. While Wall Street firms have to mark their positions to the market price at the end of each quarter, banks can opt to hold the loans until they mature, avoiding market fluctuations.
Analysts at Lehman calculate that Morgan Stanley has been the most aggressive, writing down its leveraged loan portfolio to 91 per cent of face value by last November. Barclays has taken a hit of just 2 per cent.
Some of the discrepancy can be ex-plained by banks’ varying exposures to different loans, each of which has a different price. Some banks have also managed their exposure by hedging their portfolio.
Nevertheless, any lender marking its portfolio to market prices is bound to suffer further. On average, leveraged loans are now valued at about 85 per cent of face value, and some trade below 80 per cent. This helps explain why JPMorgan Chase this year indicated it was planning to hold some loans because it felt they were worth more than market prices suggested.
But the decision to hold on to loans is not without cost. Accounting rules make it difficult for banks to sell off the loans if prices recover. And under Basel II capital rules, banks must hold large amounts of capital against sub-investment grade loans on their balance sheets, limiting their ability to make new loans.