Some Thoughts On Lev Finance’s New World Order

As those who have suffered through previous down cycles will tell you, the sky is not falling—it never really falls. But man, can it droop. And right about now, it’s drooping like it longs to touch bottom.

When the heavens finally heave themselves up again, the landscape in U.S. leveraged finance, as in all of the financial world, will have drastically changed. And while I feel queasy about whipping out my crystal ball, considering how quickly and unexpectedly the world turns itself inside out these days, I do have a few thoughts on where we’ll land when the markets turn…

Back to the Future: Once upon a time, a few large commercial banks underwrote corporate bank loans, and a few large securities firms handled high yield bonds.  With the current consolidation, American banks are returning to a similar scenario. With Bear Stearns, Lehman Brothers and Merrill Lynch gobbled up, and for argument’s sake let’s say Morgan Stanley does merge with Wachovia, the U.S. leveraged finance business at the bulge-bracket end will come down to five American players: JPMorgan, Bank of America, Citigroup, the Morgan/Wachovia combo, and Goldman Sachs, if it holds on as the last stand-alone U.S. investment bank.

1 + 1 = 1.5: Obviously, these players will remain powerhouses, but does that mean we should add, for example, BofA’s previous deals to Merrill’s previous deals to predict their combined deal volume moving forward? Not necessarily. As one investor pointed out, historically when banks have merged, the amount of credit they provide post merger is less than the amount they provided as individual organizations. Meaning not only that the number of players willing to provide capital to subinvestment-grade companies will be reduced, but their total willingness to supply capital will be reduced, especially in the new world of diminished risk tolerance.

The British are Coming… and maybe the French, and the Canadians, and the Japanese: So who will fill the void, with fewer players and less willingness to lend being the norm? Well, there will certainly be plenty of club deals. But many foreign banks have been hungry for a bigger presence in U.S. leveraged finance for years now. Credit Suisse and Deutsche Bank already have Top 10 spots on the U.S. leveraged loan and high yield bond league tables. And now Barclays, with its acquisition of much of Lehman’s American I-banking business, will likely join them. Barclays—along with British competitor HSBC (also rumored to be talking to Morgan Stanley) and Canada’s RBC Capital Markets—had made no secret about its ambitions in U.S. leveraged finance. Now it has found its vessel. And there are others—French bank BNP Paribas certainly wouldn’t sneeze at the right opportunity to increase its U.S. presence, and Japanese bank Nomura is yet another name said to be sniffing around Morgan Stanley.

Don’t Forget the Buyside: Finally, we’ve been writing about private equity firms “cutting out the investment bank middle man” for months, and now the banks appear to be doing it for them. Sell-side leveraged finance talent is heading over to private equity shops and hedge funds to lead lending efforts (as well as starting their own firms), which is not a trend that will go away. While the market at the moment is stripped of liquidity, and hedge funds look as if they have their own capital problems to deal with, the situation will not stay that way forever. Displaced talent will reappear at some point. And private equity firms remain flush with cash. Maybe they’ll concentrate on midsized club deals, but since that’s the way the market has been heading anyway, we certainly might see plenty of opportunities to go around. Once the sky stops drooping, that is.

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