Credit Woes ARE widening

By Reuters Staff
February 19, 2008

Following up on last week’s post about trouble in the leveraged loan market, the WSJ is reporting tomorrow that the big banks may be forced to take $15 billion worth of writedowns on their leveraged loan portfolios.

In case you need a refresher on leveraged loans, see that link above.

Briefly, leveraged loans were used to finance the private equity buyout boom over the last few years. Competition to work on those buyouts, and to generate the investment banking fees that go with them, was intense among the big Wall Street banks. To win the business, they often “used their balance sheets.” That is, they offered to provide or guarantee the financing so that the private equity firms could get deals done.

The idea was that there would be high demand among investors for high-yielding leveraged loan paper. For years there WAS high demand for this stuff, which is one reason yield spreads for junk debt versus treasuries reached record lows. But like real estate speculators who plowed profits back into the market only to see them evaporate when their last deal went sour, Wall Street banks now find themselves with billions of leveraged loans on their balance sheets that they couldn’t sell to investors.

The value of these loans, according to indexes which measure such things, has fallen significantly. Again, see last week’s post. It’s not likely that their value will recover before banks close their next fiscal quarter, which means they’ll have to write down their value.

If the trend holds, analysts and investors are bracing for as much as $15 billion in leveraged-loan-related write-downs at commercial and investment banks in the first quarter, further depleting capital levels already sapped by the mortgage mess. Estimates of the markdowns range from 2% to 10%.

To be sure, the writedowns on leveraged loans aren’t going to approach the size of writedowns related to subprime mortgage-backed securities and CDOs, which have already surpassed $100 billion. But these aren’t going to be the last writedowns either.

Who has the most exposure? Citi leads the pack with $43 billion of leveraged loans on their balance sheet. Goldman is second with $36 billion. JP Morgan Chase has $26 billion. Royal Bank of Scotland has $24 billion. And UBS and Credit Suisse have substantial exposure, which last week forced them to write down a combined $400 million. More writedowns may mean more trips to the well to raise capital.

But how often can these guys keep going back to sovereign wealth funds for capital infusions?

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