The huge leveraged buyouts that helped drive stocks higher this year appear to have evaporated as corporate credit gets even tighter, and that likely will stymie any quick resumption of deal making.
Even some of the nation's top buyout shops are warning not to expect a quick revival. Tony James, of Blackstone Group, recently said, "The sense that people will come back right after Labor Day is way too optimistic. It will take a while to work through these issues."
Indeed, the cheap credit that fed the buyout boom has dried up, and that jeopardizes major deals still waiting for financing. Banks are said to be having a hard time finding investors to back loans for a number of private equity deals, including First Data Corp., TXU Corp. and H&R Block Inc.'s sale of Option One Mortgage Corp.
The closed credit market began as major banks have become nervous about large loans on their books. And there is increasing pressure on private equity firms to renegotiate deals to lessen the amount of money borrowed.
Cerberus Capital Management last month had to renegotiate its takeover of Chrysler Group from Daimler and inject more equity into the transaction. Then Home Depot Inc. lowered the sale price on its wholesale supply unit by 17 percent to complete its sale to private equity firms.
Banks, which signed agreements to back private equity deals with virtually no financing outs, are under pressure. It's more difficult for them to back out of a deal than for a private equity firm to walk away from a takeover, and that's changing the playing field.
"If there's no buyers for the assets that you are to distribute, then you take a hit. You've basically got to mark down the assets," said Nick Hill, director in the financial institutions group at Standard & Poor's.
This is expected to cut into earnings for big corporate lenders. Standard & Poor's estimates major U.S. banks could see debt underwriting cut in half compared with the first half of the year.
Revenue from debt underwriting in the first half of 2007 came to $1.69 billion for JPMorgan, $1.52 billion for Citigroup and $1.11 billion for Bank of America Corp. They declined to comment on how the credit markets are affecting third-quarter results.
Major banks expect to operate in a fairly tight environment for the time being, especially with some pretty big loan obligations on tap. So far this year, they've helped fund about $465.5 billion worth of private equity transactions and are on the hook to finance another 285 deals worth $535.6 billion, according to data provider Dealogic.
Overall, there are about 3,567 private equity and corporate takeover bids pending globally, worth some $1.7 trillion. The first big test for credit markets will come this month when the banks will focus on trying to get some big debt offerings completed.
Kohlberg Kravis Roberts' $28 billion acquisition of First Data will be the litmus test for the entire private equity industry, analysts said. First Data needs to raise about $8 billion in bonds and $14 billion in loans, and there was talk Thursday that the deal might need to be renegotiated.
Another deal that could be at risk is the sale of H&R Block's subprime mortgage unit Option One Mortgage to Cerberus. Both sides are trying to modify the terms, but H&R Block said Thursday "there can be no assurance" a deal will close.
This could be the beginning of a slowdown for mergers and acquisitions, though analysts believe deals will continue.
"You can always make money if you buy at the right price, and even if you overpay, then you have to pick the right time to sell," said Donna Hitscherich, professor of finance and economics at Columbia Business School. "What you're seeing now is a more sober approach."
