When the credit crunch ends, should investment banks go back to financing private equity deals as well as advising on them?The numbers suggest not. Over the past five years, the world’s biggest banks have earned almost $67bn in fees from bankrolling the buy-out funds, representing about 19 per cent of global investment banking revenue, according to Dealogic.
Assuming that 60 per cent of the fees goes towards paying bonuses and other associated costs, the banks clear roughly $26bn in profits.
So far, net of hedges, these firms have written down about $10bn on their leveraged loan commitments to private equity deals. What’s more, the banks could be forced to write down the value of these loans stuck on their balance sheets by a further $20bn. In other words, after five years’ work, they end up in the red.
It isn’t that different from reinsurance: companies get a premium every year on their products, but as soon as a hurricane hits, years of profits are wiped out overnight.
But reinsurance firms always factor in this risk, whereas banks have failed to price in the risk of this credit storm.
So it should come as some relief to the banks that private equity luminaries such as Guy Hands and David Rubenstein have said they don’t need Wall Street any more. The chief of Terra Firma and the head of Carlyleannounced last week their plans to bypass the banks and go straight to sovereign wealth and pension funds to finance deals.
This may sound like a good idea on paper, but in reality, it is a little absurd.
Banks can make a market for trading bonds and providing advice, and they have large distribution and sales force networks to do this efficiently. Sovereign wealth funds do not.
If Carlyle and Terra Firma wanted to hold those bonds forever, they wouldn’t need the banks. But they won’t hold them forever and when they turn to the banks for help, they should expect to be charged higher fees.