Upfront
OPINION^ INTERNATIONAL FINANCING REVIEWThis time it’s different
I
nternational regulators including the US Federal Reserve
and the Bank of England are lining up to take a pop at
LEVERAGEDûLOANSûASûTHEûNEXTûINSTRUMENTûOFûlNANCIALû
destruction. Last week, it was former Fed Chair Janet Yellen’s
turn to highlight the risks.
This is raising the ire of beleaguered bankers.
“It feels like a popular knee-jerk reaction to something
they don’t really understand,” a senior loan banker said. “It’s
like a bunch of 1950s housewives trying to regulate the
internet.”
Higher leverage levels are attracting regulators’ attention,
BUTûBANKERSûSAYûTHISûREmECTSûHIGHERûCOMPANYûVALUATIONSûANDû
toppy equity markets, rather than heralding the next
meltdown.
Although it’s easy to criticise leverage, the main problem
in the last crisis was that liquidity dried up, which was a sign
of other problems elsewhere. Senior secured loans largely
did what they were supposed to do, while credit losses were
limited.
Regulators are also arguing that structural changes,
primarily the rise of covenant-lite loans, could be the source
of a wave of bankruptcies in the downturn. The Bank of
England went as far as comparing leveraged loans to the
2008-vintage sub-prime market.
Bankers say that covenants do not necessarily make a
difference, as repayment comes down to the quality of
credits and whether they are appropriately leveraged.
They believe that regulators are jumping on the
bandwagon for fear of being seen as tacitly endorsing
current conditions.
This time around, specialised loan funds – primarily CLOs –
are the biggest lenders, rather than banks, and their main
investors are other funds. The percentage of leveraged loans
that each fund holds is relatively small, which bankers say
could minimise the impact of a 10%–15% drop in mark-to-
market values.
And yet, bankers should guard against complacency. After
all, there were plenty of people in 2007 who were convinced
that all was well.
No one thinks that leveraged lending – and the CLOs that
support it – will cause a crisis on the scale of 2008. But the
parallels are undeniable.
Financial markets history has a habit of repeating itself,
and the interplay between various market participants using
structured credit technology is once more allowing bad
credits to get loans they shouldn’t get – and at levels that are
SIMPLYûNOTûREmECTIVEûOFûRISKS
That should be a worry. And the regulators are right to
sound the alarm.
Heads in the sand
F
or the past three years, investment banks have been
willing to turn a blind eye to some of Saudi Arabia’s more
unpleasant practices.
Some would say that it is not for bankers to judge such
issues, that there are other objectionable regimes that
bankers are not criticised for servicing, and that it’s easy for
those without a pay cheque on the line to take the moral
high ground. Others say that everyone has their price.
Certainly, the pot of gold on the horizon in Saudi has
SEEMEDûSUFlCIENTLYûLARGEûFORûMANYûTOûSETûASIDEûTHEIRû
objections. Many expect Crown Prince Mohammed bin
Salman’s ambitious Vision 2030 programme of reform to
rain down billions in fees on the industry over coming years.
But the murder of Jamal Khashoggi at the Saudi consulate
in Istanbul seems rapidly to be tipping the balance for some
banks.
Judging from the actions of the dozens of bankers who
ATTENDEDûTHEûCROWNûPRINCESûmAGSHIPû&UTUREû)NVESTMENTû
Initiative conference in Riyadh this last week, the
reputational damage of being seen to be working with the
kingdom has become something they can no longer ignore.
Bankers who would normally have been pacing the
corridors shaking hands were largely locked away out of the
MEDIASûSIGHTû*USTûAûFEWûWEEKSûAGO û#%/SûWOULDûmYûREGULARLYû
to Riyadh to show their commitment in front of the camera.
Now, they are only willing to show support for the regime
if they can do it behind closed doors.
All this is important because the Saudis still need cash – a
lot of it. Vision 2030 is expected to cost hundreds of billions
OFûDOLLARSû4HEû3AUDIûGOVERNMENTûISûRUNNINGûAûBIGûDElCITû4HEû
money needs to be borrowed from banks and investors
abroad.
It’s one thing to show your support for Riyadh in the back
rooms of a conference building. It is quite another to publicly
lend money, or underwrite a bond or equity deal. One day
soon, banks will be asked to show their commitment in plain
view of the wider public (and the media).
Of course, the outrage over the death of Khashoggi may
just go away. But judging from some actions of the Saudis
over the past few years, it may not be long before another
misjudged action forces banks into the same situation.
Coupled with all this are the numbers. Banks have been
bitterly disappointed by the lack of fees out of Saudi. Despite
all the promise, fees are well down from their peak over a
decade ago. Many have heaped huge resources on the
kingdom, but have little to show for those efforts – apart
from the risk to their reputations.
We might soon see that the price isn’t high enough for
some banks to continue their support.