How LevFin Group is taking huge underwriting losses recently?
Hello All,
Words on the street that LevFin groups at major banks are taking a huge loss, especially Jefferies and some other banks. I know LevFin transaction is essentially linked to the volume of M&A, which is not optimistic at all.
But can anyone explain how those banks suffer from underwriting loss?
- Borrower default?
- Bond issues were already in place but high-interest rate and yield leads to banks having to sell the bond cheaper to stop further loss?
- If not bond, how do banks suffer loss from RCF, Term Loan, or PIK Note underwriting?
- Any other reason given recent situation?
Thanks a lot
Say a bank commits to underwrite a transaction @ 5% when risk free rate is @ 2% b/c they think that's the appropriate level to clear the market. The transaction doesn't close for weeks and over that short window risk free rate soars to 4%, investors in turn now demand a much higher yield for the same credit. In order to meet the new required yield from that same piece of paper, banks need to syndicate the loan/bond at a discount to boost yield when coupon remains flat. (E.g. if investors now want 7% yield, then banks need to syndicate at ~70 cents on the dollar). Banks need to recycle capital to underwrite new deals for fees to boost RoE, so holding the bag isn’t really an option, nor is it their mandate
These groups take losses because they have to sell the debt at a discount to get it off their books.
Let’s use your jefferies as our example.
Jefferies is an originate to distribute bank. They have no real balance sheet and have zero interest in holding the term loan or revolver debt. They win deals by winning the lead mandate and then underwrite or best efforts the debt.
If they underwrite the debt, the structure the fees in such a way that they expect to make money from the lead fees minus what it takes to place the debt in the market.
If yields spike in between winning the deal and by the time the debt has to be sold to market, the discounts could eat up all their profits and even cause them to take the loss.
Bigger banks like JPM with large deposit bases may be able to hold the debt for a little longer than a smaller bank by jefferies, but eventually their risk people will require them to off load the debt, even at a loss because they want that risk of their plates.
In theory, banks could just hold the debt to maturity, but they don’t ever do that and would rather take an immediate loss now, than a potential huge loss in the future if the company whose debt they held would go bankrupt.
Above comment is accurate, but just to be clear: no single investment bank, even with larger balance sheets like a JPM or a Bofa are looking to hold debt on their balance sheet so they would always be looking to off-load. Moreover, in case deals are hung and need to be pulled, or a bridge is financed, a 'risk' person isn't calling the shots at all - it will be LevFin and Capital Market markets team who will be in charge here. There are definitely some banks taking big losses right now, most notably those involved on Morissons, Citrix, Twitter and Lightspeed
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My brother in Christ...
Source: An ASO1 at CS….probably
inaccurate re jefferies, they have lost far less than the other major LF banks by avoiding large econs of the major LBOs that have blown up this year i.e. citrix and soon to be twitter among others. CS, BofA, and soon to be MS are the hardest hit banks this year in LevFin.
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