European bankers say the writedown of debt impairments in the third and fourth quarters has been extremely uneven, making it difficult to assess fully the extent of the problems facing the market. The numbers reported by UK-based banks are viewed with particular scepticism.
There is limited appetite for regulations to create a single impairment writedown model. Despite a bruising second half of the year, most bankers do not expect to see rivals exit the space in 2008.
The poll of loan bankers suggests the market will not be fully functioning again until well into 2008 – one suggested 2008 could bring “a year of misery”.
With banks holding a huge inventory of hung deals – debt underwritten in 2007 that they have not been able to syndicate – the writedown process should make explicit the impairment assumptions being made and clarify the level of exposure to leveraged debt across the market.
The lack of transparency makes it difficult to know where and how great problems are. Uncertainty around the price of paper has a negative impact on market confidence and means banks’ capital positions are also unclear.
While investment banks in particular insist that every deal is marked to market every day, the absence of clarity on market clearing prices means in reality the exercise is far from clear cut.
A dearth of liquidity complicates the issue, according to one commercial banker, who says: “It can be difficult identifying the mark when there is no market, you have to consider ‘where would it sell?’ not ‘where is it selling?'”
Others agree, saying: “There may be a question of looking at the coupon and assessing where it would have to be now to sell – a one-time 200bp–250bp margin deal is now a 325bp deal.”
An investment banker takes up the point. “Marks have to be referenced to secondary trading levels, but also indices, investor yield requirements and recent experience and comparable transactions,” he says.
While respondents feel their own assumptions are robust there is less faith in those of rivals.
“Everybody can see what is on each others’ books and make an estimate of where it could be sold,” says a commercial banker. “With that in mind, I cannot understand some of the numbers coming from other banks. I don’t want to name them but there are banks with deals, sterling deals in particular, and there is no relation between what we know and what they have said.”
Another source concurs, saying: “There is a competitor with 2-1/2-times the exposure we have in Europe, yet its entire global markdown is less than ours in Europe alone. There is a flaw with a situation where a deal can be valued at par simply because it has not been syndicated.”
“There are banks holding huge overhang inventory close to fees and refusing to sell this year below those levels – it is horrible risk management,” says another clearly exasperated investment banker.
Asked whether writedowns will be worse in the next results season, there is no real consensus among bankers. One argues that optimistic writedowns in the third quarter would return to haunt some banks, saying: “Realisations will come later for banks that felt it would be easier to sell down debt in the fourth quarter than it proved.”
Given the greater sell-down of US inventory in October, there is a perception that Europe is less well placed in this regard than the US.
Alliance Boots and AA/Saga are the deals most respondents identify as the longest positions currently held in Europe, with many seeing their sterling denomination as a further barrier to syndication in the near term.
Tough new year
The first two quarters of next year will see a continuation of existing tough market conditions, according to most observers, with some predicting all of 2008 will be difficult.
“The recovery may well be very slow, even taking years to return to previous ‘normal’ levels. But the industry is functioning daily, it just needs its attention, capital and manpower focused in the right places – which are not large new issue LBOs right now,” according to one source.
Others are more optimistic. “Hopefully, after Easter there should be clarity around full exposure to sub-prime as well as leveraged loans, and central bank injections of liquidity help to restore an orderly market,” says another source.
“There are too many vested interests wanting a return to normal conditions for it not to happen. No doubt there will be hiccups along the way given how fragile sentiment is, and a US/European recession or greater fears of a recession would delay a recovery.”
Few bankers in Europe foresee a properly functioning market before the third quarter, though a minority dared to hope for a pick-up late in the first half.
Despite the disquiet expressed by many about the uneven and confusing writedown assumptions made across the sector, there is no general clamour for a regulatory solution.
Investment bankers on the whole tend to be more in favour of conditions that create “consistency of treatment”. Others see the issue as one for existing regulators. “National regulators and central banks will look at this if they feel their principal large banks are impaired by their assumptions,” says one. “Some banks are vulnerable.”
The writedown of impairments is just one part of the end of year review taking place in every bank. In contrast to the optimistic end to 2006, all banks face the coming year on a defensive footing, though sources say that is unlikely to mean the exit of banks from the leveraged space.
“There may be some exits at the periphery,” according to one source, “but for most banks financial sponsor revenues remain too large a part of the fee pie to exit the business.”
Others agree, pointing out that writedowns are not losses. Leveraged lending remains a low default business.
There is a view though that the size and focus of some banks’ operations will change, in particular shifting from arranging to investing. “Some of those who tried to build a franchise will have to right size, and whether everyone is going to be originating debt is a question,” says one observer.
One thing the discussion around writedowns does make clear is that arranging leveraged debt has become a far riskier proposition.