By Saeed Azhar, Anirban Sen and Davide Barbuscia

NEW YORK (Reuters) -High U.S. and European banks are going through harder instances within the riskiest components of the mortgage market.

The largest U.S. lenders, together with Financial institution of America and Citigroup, wrote down $1 billion within the second quarter on leveraged and bridge loans as rising rates of interest made it harder for banks to dump debt to traders and different lenders.

The ache has additionally unfold throughout the Atlantic, after European lenders corresponding to Deutsche Financial institution and Credit score Suisse reported losses for such publicity.

Massive U.S. and European banks are on observe to lose $5 billion to $10 billion extra in coming quarters on leveraged loans they’ve dedicated to underwrite, in response to bankers and analysts.

Financial institution of America is amongst these most uncovered to such writedowns as a result of it’s financing at the least three giant buyout offers at a time when the LBO market has come to a standstill, bankers and analysts mentioned. Financial institution of America declined to remark.

Within the leveraged mortgage market, banks sometimes make higher-risk loans to traders who wish to buy corporations utilizing the borrowed funds. Because the market slowed, banks have responded with extra stringent phrases for brand new loans whereas struggling to distribute present loans to different lenders and institutional traders. Consumers are in search of extra favorable phrases.

“If a financial institution desires to push a deal on to the market to traders, they’ll need to carry it at a reduction,” mentioned Dan DeYoung, excessive yield and leveraged mortgage portfolio supervisor at fund supervisor Columbia Threadneedle.

Goldman Sachs, Financial institution of America and Barclays are among the many prime three bookrunners for leverage buyout financing for each leveraged loans and bonds because the fourth quarter of 2021 in the USA and Europe, in response to knowledge from Dealogic.

Goldman Sachs and Barclays declined to remark.

Banks sometimes promote the loans reasonably than holding them. They wish to distribute about $80 billion to $100 billion of U.S. and European leveraged loans to different lenders and traders in September and October, a delay within the course of resulting from market disruption, in response to three bankers concerned out there. If they’re bought at a reduction, the underwriters must swallow some losses, the bankers mentioned.

The market was disrupted by the Federal Reserve’s plan to tighten financial coverage to combat inflation, which sparked a pointy sell-off throughout fixed-income belongings this 12 months.

    The yield unfold on the ICE BofA U.S. Excessive Yield Index, a generally used benchmark for the junk bond market, rose to a two-year excessive of round 600 foundation factors in July. It has narrowed to 425 foundation factors, however continues to be up 120 bps because the starting of the 12 months.

“All of us underestimated how massive a difficulty inflation was, and the way aggressively the Fed was going to have to maneuver,” mentioned a senior mortgage banker in New York.

“Quite a few the commitments that we wrote within the fourth quarter, and in January and early February, had been rapidly underwater as a result of the charges had been so aggressive,” he mentioned.

The larger offers embody Financial institution of America-led financing for a $16.5 billion buyout of software program firm Citrix Techniques Inc by associates of Elliott Administration and Vista Fairness Companions. The lender can also be financing Apollo’s deal to purchase Tenneco Inc which had an enterprise valuation of about $7.1 billion, together with debt.

Financial institution of America can also be among the many banks backing billionaire Elon Musk’s $44 billion acquisition of Twitter Inc, a deal placed on maintain after Musk backed out. Twitter has sued to pressure him to finish the transaction.

For some, the market uncertainty deserves a wait-and-see method.

“The debt dedicated within the system must get positioned and the fairness traders … are being cautious, which is limiting LBO exercise,” mentioned Anu Aiyengar, international co-head of M&A at J.P. Morgan, referring to leveraged buyouts.

The worth of present loans on the S&P Leveraged Mortgage Index fell to a two-year low in July, in response to Refinitiv knowledge. Whereas it has pared losses, the index’s decline this 12 months displays broader stress on the debt markets and rising considerations that the Fed’s financial tightening could stress riskier debtors. Two exchange-traded funds that observe leveraged loans, the SPDR Blackstone Senior Mortgage ETF and the Invesco Senior Mortgage ETF, have dropped 4.9% and three%, respectively, because the starting of the 12 months.

“Each the supply and value of debt financing for sponsors has turn into a problem in some conditions, notably within the syndicated mortgage markets,” mentioned Steve Arcano, a world head of transactions practices for legislation agency Skadden, Arps, Slate, Meagher & Flom LLP, concerning the problem confronted by buyout companies.

The credit score market is present process a wave of repricing after the Fed’s price hikes, in response to Minesh Patel, a senior director at S&P World Rankings.

“The true crux of the problem is that the markets have shifted,” Patel mentioned. Borrowing charges have gotten dearer for corporations with decrease credit score scores, he mentioned, citing an S&P examine he co-authored.

Leveraged finance has been profitable for giant banks in recent times, so the anticipated losses is not going to be too alarming, mentioned Marc Cooper, chief government of Solomon Companions, a boutique funding financial institution in New York.

Massive banks are “going to get crushed” within the newest bout of volatility, however “they’re massive boys,” he mentioned. “They will take their writeoffs and transfer on.”

(Reporting by Saeed Azhar, Anirban Sen and Davide Barbuscia in New York; Extra reporting by Chibuike Oguh and Lananh Nguyen; Enhancing by Richard Chang)

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