According to a report by JP Morgan Chase, large banks have lost about $2 billion due to the sudden outflows from their funds and the tightening conditions in the credit markets.
According to a research note by analyst Vivek Juneja of JP Morgan Chase, Bank of America and Citigroup are the biggest holders of so-called hanging loan deals. Both banks did not comment on the report.
A mortgaged loan is a type of loan a bank provides for a company's acquisition. It usually involves a short-term financing arrangement with a group of investors.
If the market conditions change suddenly, the bank that provides the credit may have to sell the debt at a discount or keep the loans in the deal to maintain its profitability.
The mortgaged loan market is a vital part of the private equity industry, allowing companies to finance their acquisitions. However, in recent weeks, the market has started to slow down due to concerns about a potential recession.
According to the report, the leveraged loan funds have experienced their most substantial outflows since the pandemic in 2020. They had outflows of around $3 billion in May and another $2 billion in June. Juneja noted that there are approximately $41 billion in loans on 12 suspended deals.
Juneja said the average price drop on the hanging deals could be around $2 billion. He said that these deals would lose money if the market conditions changed.
Bank of America, Citigroup under scrutiny
Juneja also said that Bank of America is the biggest holder of so-called hanging loan deals, as it is involved in nine of the 12 transactions. In late May, Bank of America's chief financial officer said the company was looking at possible write-downs of up to $150 million on the remaining deals.
In addition, a surprising number of the hanging loan deals involved Citigroup, which raises questions about the bank's risk management. For the past three years, Bank of America has been the dominant player in the leveraged loan market, and Citigroup has been a relatively small player in the market.
Despite being ranked seventh in 2021, Citigroup still participated in five quoted hanging loan deals. This is a significant increase from its previous position.
Despite being the second and third-largest players in the market, respectively, Wells Fargo and JPMorgan only participated in two suspended deals. Several global investment banks, such as Goldman Sachs, Morgan Stanley, and Credit Suisse, also participated in multiple fixed transactions during the second quarter.
Despite the slight decline in the price of leveraged loans so far in 2021, they could still fall further if the economy worsens. These types of loans are considered risky because they are typically taken out by heavily indebted companies.
If the economy worsens, the cost of doing business will likely increase for banks involved in suspended deals. This could cause them to lose money on the loans. Juneja noted that the increasing pressure on the lending industry would also lead to more losses.
"Losses on these suspended loans are likely to vary considerably depending on the deal and role of each bookrunner; banks with larger roles would incur higher fees but would also incur more losses," said Juneja. "There will likely be increased pressure, and thus more losses, as the Fed tightens further."