Back in September 2007, at the beginning of the financial crisis, Deutsche Bank admitted that it was saddled with €29 billion ($33.6 billion) in so-called leveraged loans, cash lent to highly indebted companies that have low credit ratings. It ended up having to write off billions of euros of it.
Fast forward 11 years and that sorry tale seems forgotten by Germany’s largest bank as well as many other major lenders. Leveraged loans, which are lucrative because they offer higher interest rates and yield mouthwatering arrangement fees, are back in fashion. Debt in this category reached a new all-time high of $1.06 trillion in the US at the end of July.
Despite it being only 10 years since the collapse of Lehman Brothers, investors and banks thirsting for yields are today increasingly willing to accept ever-higher debt levels on ever shakier terms. The market is booming because mergers and acquisitions are booming, and the loans are often needed to fund leveraged buyouts.
Deutsche Bank, still battling to complete a restructuring and boost its profitability and capital base in the wake of the crisis, has advanced from seventh to fifth place in the global leveraged loan market.
“(Deutsche CEO) Christian Sewing, (investment banking head) Garth Ritchie and I are very receptive to the needs in the leveraged finance business as long as we take calculated risks and act responsibly,” Mark Fedorcik, co-president of the investment banking division, told Handelsblatt. “It’s been one of our focal points for over 15 years.”
For now, investors and borrowers feel safe because the default rates are low. But that could change quickly, as the financial crisis showed.
Meanwhile, US regulators have whipped up sentiment by relaxing restrictions. Fed Chairman Jerome Powell said in February that a debt ceiling limiting a company’s borrowing to six times its earnings before interest, tax, depreciation and amortization (Ebitda) was not binding. That spurred on the global market.
For example, Britain’s Barclays recently helped US group Aveanna Healthcare buy a competitor in a $221 million deal that lifted the company’s debt to 10 times its earnings.
Investors are so hungry that they’ve accepted a watering down of so-called covenants — protection mechanisms that require borrowers to stick to terms such as debt ceilings or guarantees to repay their debts sooner if they sell collateral. A study by rating agency Moody’s said the covenants being accepted this year were weaker than ever. At the end of July, 78 percent of leveraged loans in the US were “covenant lite.” Rates have soared in Germany, too
As long as the companies survive, everyone’s happy. But if there’s a crisis, the default rates for these loans could surge. Moody’s has an indicator that measures how strongly investors are protected. On a scale between 1 (very strong protection) and 5 (weak protection), the indicator reached a record high of 4.12 in the first quarter.
Many banks see the loans as a risk worth taking in this era of ultra-low interest rates. Fees for arranging leveraged loan deals reached $9.1 billion worldwide and will likely amount to $22.1 billion for the full year, according to Freeman Consulting Services. That would be an increase of 18 percent.
But the banks don’t have it all their own way. The big players in the market, who include the major US banks, Japan’s Nomura, Deutsche Bank and Barclays, share it with firms that are less tightly regulated. They include private equity companies such as KKR, Carlyle and Blackrock, who are eating into their business.
The banks act mainly as intermediates that lend money to private equity firms until a bond or a loan can be placed with investors. In the financial crisis, banks got burned when they were left with unsold loans on their books.
They insist, however, that they’ve learned their lesson. “These days a bank doesn’t fund such a transaction on its own but together with five, six, seven other banks,” said an executive at one bank active in the market. That enables them to spread the risk.
But whether Deutsche Bank et all can party hard now and avoid a financial crisis-sized hangover later remains to be seen.
Astrid Dörner is a Handelsblatt editor in New York. Yasmin Osman is a financial editor with Handelsblatt’s banking team. Carsten Volkery is Handelsblatt’s correspondent in London. To contact the authors: firstname.lastname@example.org, email@example.com, firstname.lastname@example.org