Investors in telecom have lost billions as these soaring stocks crashed to earth. But that's just the beginning of the damage from the meltdown. Next in the line are investment and commercial banks, insurance companies, and asset managers that lent money to telecom companies or bought their bonds.
It's hard to say how big the bill will be. But the total cost could be in the same league as the $150 billion taxpayer bailout of bankrupt savings and loans in the late 1980s. And it might even drive a few banks to the wall.
This time, taxpayers won't have to dip directly into their pockets. That's because the banking system is in better shape now: It's better capitalized, with bigger reserves and a wider diversification of risks. Nevertheless, shareholders will see profits dwindle as loans and bonds are written off, while investors in some junk-bond mutual funds will be hit with losses.
That's going to be painful. Banks issued more than $320 billion in syndicated loans--in which several banks band together to lend to one company--to the telecom industry since 1999, says Thomson Financial Securities Data. Telecoms issued more than $160 billion in bonds, says Capital Access International, held by insurers, pension funds, and money managers.
PIDDLING. Worse yet, the amounts recovered from busted bonds or failed companies could be pitifully small. NorthPoint Communications Group Inc. (NPNTQ ), for example, filed for bankruptcy on Jan. 17, owing more than $850 million in five syndicated loans led by CIBC Oppenheimer and Goldman, Sachs & Co. NorthPoint loan debt trades at less than 25 cents on the dollar, according to LSTA-LPC Market to Market Pricing. Winstar Communications (WCII ) and RCN Corp. (RCNC ) have both reported widening losses and staff cuts, while their stock has fallen far. RCN has $3 billion in loans and more than $800 million in outstanding bonds. Winstar has over $1 billion in bonds alone. If either company is forced to close its doors, investors' losses will be severe.
The problem is that the assets of bankrupt telecoms, mainly customer lists and hardware, have little value. If they're forced to file, "bondholders won't get anything, while the banks will take a significant haircut," predicts one banker.
So banks and insurers will be forced to take write-downs and shore up reserves as loan values drop. It's starting already. On Mar. 27, Bank One Corp. (ONE ) said this year's commercial loan losses could double, to about $1.2 billion, in part because of exposure to the telecom industry.
Some bankers, however, have dodged the bullet. J.P. Morgan Chase (JPM ), Goldman Sachs (GS ), and Bank of America (BAC ) were the top three syndicated lenders to the sector, but they say they've sold off most of the loans. Bank of America, for example, said the bank holds $6.8 billion, or 3% of its overall loan portfolio, in telecom loans out of the $31 billion it issued since 1999. Now insurance companies and pension funds hold almost half of the outstanding telecom loans, estimates Standard & Poor's--like BusinessWeek, a unit of The McGraw-Hill Companies. Leading telecom bondholders include Prudential Asset Management, Metropolitan Life, and Fidelity Investments. None of the three companies would comment on their exposure.
Even the bankers now admit they went overboard. In hindsight, "anyone active in the business wrote one or two deals too many a year ago," says one telecom banker who didn't want to be named. As the telecom meltdown runs its course, that could prove to be the understatement of the decade.
By Heather Timmons in New York