October 5, 2007
Here’s some money to buy our loans
The FT reports today on a strange new market in leveraged loans being cooked up by large banks and investment funds.
The report caps a week of banks including Deutsche, Citigroup and UBS reporting billion-dollar write-downs on leveraged loan commitments. Merrill today disclosed $5.5 billion write-down of collateralised debt obligations, subprime mortgages and leveraged loans.
There is something both mind-boggling and potentially suspicious about a bank’s debt being used to buy its debt. Dealbreaker suggested facetiously yesterday that it was a giant Ponzi scheme (named after the man pictured above left).
Regulators will want to be assured that it is not merely a backhand way of banks boosting the value of impaired debt by selling it to themselves at artificially high prices.
But, for all that, I think it is a good thing.
Not so long ago, everyone was worried that up to $400bn of impaired leveraged debt would sit around on banks’ balance sheets and cause a credit crunch, rather as it did when Japanese banks refused to take big loan write-offs in the 1990s.
Finding a good way to sell impaired debt to someone else and get back to normal business as quickly as possible is essential for banks to weather the credit squeeze. That, after all, was the point of the "bad banks" set up to relieve Scandinavian banks of bad debts around the same time.
This time, as I predicted it might the other day, the process of investors lining up to buy impaired debt, is happening rapidly. It seems like a good wheeze for a bank to extend credit to such funds to buy its own debt, providing they are putting in enough equity. The bank potentially gets rid of the original credit risk without taking on much the second time around.
No wonder the stock market is feeling happy.
