Wall Street banks are taking steep losses on corporate bond deals signed before the latest downturn in financial markets, as investors demand bigger discounts and higher yields to lend to companies.
When banks agree bond sales on behalf of companies, they typically set a maximum interest rate that investors can expect to receive in exchange for buying the debt — factoring in some flexibility in case markets move.
But markets have dropped much further than envisaged in 2022, as high inflation, war in Europe and constrained supply chains have been met by central banks lifting borrowing costs and withdrawing vast debt-buying programmes. An index of high-yield bonds run by Ice Data Services has dropped nearly 13 per cent so far in 2022.
In turn, investment banks have cut the prices of companies’ bonds in an effort to attract buyers — eating into their underwriting fees. “Almost every single deal that was underwritten will have to come at a discount and underwriters are having to pay for it,” said a banker at a large US bank.
Packaging group Intertape Polymer, which has a low credit rating, borrowed $400mn from investors last week at an interest rate of 10 per cent. That figure marked the top end of a previously agreed cap the company was willing to pay to buyers of its bonds, when a group of banks led by Deutsche Bank agreed to underwrite the deal in March, according to people familiar with the financing.
Yet even a rate of 10 per cent was insufficiently appealing to lure lenders after the recent sell-off in bond markets, leading Deutsche to lower the price on the bond to 82 cents on the dollar. By dropping the price, the overall yield on offer — which moves in the opposite direction — rose to more than 14 per cent.
Bankers have to pay the difference when they opt to discount the price of a bond offering that they have already committed to. Multiple bankers said that for deals signed up around the time of Intertape, there would be around 2 cents of permitted discount to allow underwriters “flex” to sell the deal, followed by a further 3 cents of fees.
Ultimately, once a deal drops below roughly 95 cents on the dollar, losses rack up for the banks.
Estimates of losses on the Intertape deal are around $50mn across Deutsche Bank, Bank of Montreal, Credit Suisse, Golub Capital and Jefferies, according to people familiar with the deal. Deutsche Bank declined to comment.
Such steep discounts in the corporate bond market are rare. Only five other deals since the 2008 financial crisis have been issued at or below the 82 cent price level hit by Intertape, according to financial data provider LCD.
A second deal last week for US chip material maker Entegris, underwritten at the end of 2021 by a bank group led by Morgan Stanley, also came at a discount, just shy of 91 cents on the dollar.
The $895mn bond was issued at the highest possible agreed coupon, or interest rate, of 5.95 per cent, according to people familiar with the deal. The price discount pushed the overall yield on the bonds to 7.5 per cent. Losses for the banks — including Barclays, Bank of America, PNC, Truist and Wells Fargo along with Morgan Stanley — stood at around $35mn, according to the people.
The underwriters declined to comment.
Bankers said they have already changed their approach to underwriting new deals, building in a bigger cushion for them to sell bonds at a discount in the future while still earning their fees. But it will still take a few more months for old deals to work their way through the market, they said. Losses are expected to be painful, but manageable.
Bankers also said that companies exposed to a turn in the economic cycle have been particularly punished in the bond market, with Intertape’s deal seen as an example of this.
In the weeks ahead, one of the deals that bond investors and bankers alike are watching closely is the buyout of cloud computing group Citrix. Elliott and Vista Equity Partners in January agreed to take the company private for $16.5bn, in order to merge it with Vista-owned Tibco. With the debt sales led by Bank of America, the acquisition is expected to need billions of dollars in financing across debt markets.
Bankers are already hinting that some creativity may be needed to get the transaction over the line, once regulatory approvals are finalised. “It’s going to be a challenge in this environment,” said one banker familiar with the deal.
