Friday Letter Steady now

Panic in the credit markets: don’t expect much buyout activity any time soon.  

There is a confidence crisis in the interbank market right now, and equity and commodities markets around the world are bearing the brunt. The past few weeks have seen banks tighten their lending criteria to each other. This, according to a Royal Bank of Scotland research note, manifested in limit-cutting, shortened terms and an increase in the price of overnight money.

Banks globally are also more wary about the valuation assigned to collateral put up for these loans, RBS said.

This has meant that when banks settle with each other overnight, conditions are tougher. Until now this has not led to a genuine crunch, but has had side effects such as the increase in swap spreads.

The issue is more acute for banks reliant on wholesale markets and of course for structured investment vehicles used by the banks to reduce risk on their balance sheets, as well as the conduits that fund themselves almost entirely in the commercial paper market.

Yesterday the central banks in Europe and the US injected liquidity into the system to restore confidence into the banking market. Europe’s central bank put up more money than it did in the immediate aftermath of 9/11. It is not quite a run on the banks, but it is not far off.

Equity markets are sinking round the globe. Behind closed doors, one banker told PEO yesterday he anticipated a correction of around 10 percent in the next couple of days now share prices are no longer supported by the hot air of leveraged buyout bids. One senior debt lawyer at a magic circle firm confessed he had transferred his assets to cash.

Meanwhile in the US the US retailer Home Depot is working with Bain Capital, The Carlyle Group and Clayton Dubilier & Rice to renegotiate the agreed $10.3 billion (€7.7 billion) sale of its HD Supply division. Home Depot said it would “restructure” the terms possibly resulting in a lower sale price, citing “current financial conditions”.

It seems likely that where contracts allow other firms with buyouts pending might go back to the boardroom for fresh negotiations to soften the blow, because as PEO’s banking source said “we just don’t know how serious it is”.

Publicly bankers are putting a positive spin on the crisis. “Everybody is trying to smooth the system,” one said. It is too late now to contain the contagion, but one thing is for certain: there will be no more mega deals until confidence returns.

When it does, deals will be priced for risk and not for distribution. Welcome to the years of restraint.