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Why Banks Face Billions in ‘Hung Debt’ as Deals Cool

The Manhattan skyline.

The Manhattan skyline.

Photographer: Angela Weiss/AFP/Getty Images

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One of the most lucrative transactions in investment banking has suddenly become a very expensive headache for US and European banks. They’re facing big potential losses from about $80 billion in acquisition debt that they promised to raise to facilitate mergers and leveraged buyouts when financial conditions were better. The likes of Bank of America Corp., Credit Suisse Group AG and Goldman Sachs Group Inc. could each face a $100 million hit on the so-called hung debt from just one such financing deal alone. It’s not the first time banks have been burned when what’s known as committed financing turns sour quickly. Banks are better able to withstand such losses now than they were in the financial crisis of 2008. But as happened before, the experience appears to be contributing to a chill in deal-making.

These are financings for mergers and leveraged buyouts (acquisitions loaded with high levels of debt) that involve what’s known as leveraged finance, a term that refers to the debt of companies that are rated below investment grade -- so-called junk. Banks once used to make such loans directly but now they operate as a middleman helping such companies raise capital from investors. This approach has become increasingly important for banks and “arranging” such debt accounted for about a third of investment banking revenue in recent years. But a crucial part of the process involves banks acting in effect as a backstop lender, offering committed financing -- and in doing so, putting themselves on the hook for the money needed to make a deal go through, ideally briefly.