A resurgence in the leveraged buyout market could boost the investment banking fees of the big U.S. banks, but it would also boost their balance sheet risk, cautions Fitch Ratings.
In a new report, the rating agency says that tentative signs of a pickup in large leveraged buyout and M&A transactions, financed in large part by leveraged loans, may boost fee revenues for major U.S. banks in the first quarter. But, Fitch says that it also sees the potential for any sustained rise in deal activity to increase balance-sheet risk for the banks in the process.
Notwithstanding the slow-growth economic environment, Fitch notes that the foundation for leveraged dealmaking is solid, with healthy U.S. corporate cash positions, a wave of refinancing activity by firms that has increased the amount of cash available for acquisitions, and private equity firms with plenty of unused capital to deploy in leveraged deals. Additionally, interest rates and credit spreads remain quite low, making deal financing costs, it says.
“Although the impact of large-scale leveraged transactions on advisory fee and underwriting revenues will be positive during the first quarter, we recognize that banks may be assuming more risk on their balance sheets — both as a result of much larger deal size and higher debt-to-EBITDA multiples in some recent leveraged transactions,” it says.
In addition to retaining more risk on their balance sheets, the banks also “run the risk that any rapid rise in interest rates and credit spreads will limit their ability to sell down risk and syndicate loans”, it says. “Large exposure to leveraged credit caused problems for many banks, when liquidity evaporated in the latter part of 2007 and 2008. While current exposures fall far short of pre-crisis heights, growth in leveraged loan books nonetheless represents a risk that could grow in importance over time.”
“Still healthy high-yield bond issuance this quarter, along with the pickup in leveraged loan activity, will likely drive positive investment banking revenue comparisons for all of the large deal-making banks in [the first quarter],” Fitch says. “In addition, trading revenues will likely benefit from the favorable fixed-income environment, combined with an upswing in equity trading volumes (barring any macro issues or unforeseen problems in the last month of the quarter).”