Wall Street's Hot New Money Machine Starts With a Single Loan

(Bloomberg) -- When a group of banks led by Credit Suisse and including Barclays cut a $1 billion check to finance a buyout by Apollo Global Management back in mid-2015, they pocketed as much as $25 million in fees.

Not an insignificant nugget in its own right but it was, it turns out, just the beginning for the banks. Some of them would make a new loan for Apollo the following April and then proceed to rework the terms of that debt with the firm four separate times over the next 14 months. The dizzying succession of follow-up deals -- aimed at locking in falling borrowing costs and boosting the size of the loan -- handed the banks as much as another $45 million in fees.

The estimated total -- as high as about $70 million -- may not go down as a great windfall in the annals of Wall Street, but at a time when many of the firms’ traditional core businesses are posting low returns, the fees represent a rare source of strong revenue growth. It is one reason why banks are so aggressively handing out leveraged loans to highly indebted companies, raising concerns in the process that the market has become frothy and is now vulnerable to a downturn.

The torrent of leveraged lending last year generated a record $12.4 billion in bank fees, a 41 percent surge over 2016, said Freeman Consulting Services. About 70 percent of the almost $1 trillion of such loans in 2017 came in the form of follow-up repricings and refinancings, according to data compiled by Bloomberg.

Follow the Fees

And that’s not all. Banks reaped another $4.9 billion for packaging those risky loans into securities, as well as for selling high-yield bonds that help finance deals.

“Banks go where the fees are,” said Floyd Tyler, president of Memphis-based Preserver Partners.

In the Apollo deal, the buyout shop used the loan to acquire a home-security company called Protection 1 in 2015. The syndication of banks also included Deutsche Bank and Royal Bank of Canada.

A year later, Apollo used another $1.55 billion loan to buy ADT Corp., combining it with Protection 1. Bank fees for this loan probably amounted to between $25 million and $30 million.

The loans were subsequently rejiggered three times to cut the interest rate by 100 basis points, and increased once, by $800 million.

ADT IPO

For handling the various transactions, the banks potentially earned a total of between $50 million to $70 million. That amount is based on estimates from Freeman using data from Thomson Reuters Corp., and from people familiar with the matter, who asked not to be identified discussing a private matter.

Representatives for Apollo, Barclays Plc, Credit Suisse Group AG, RBC and Deutsche Bank AG declined to comment. Representatives for ADT didn’t respond to requests for comment.

The fee ride on this deal isn’t over yet. ADT filed in December to raise as much as $2.1 billion in an initial public offering, a process that will also generate revenue for the banks managing the stock sale.

Fees for underwriting new leveraged loans amount to around 2 percent or more of the debt. Banks hold a substantial risk if they are unable to sell the loan to other institutions.

A refinancing or repricing costs a company significantly less, with the latter sometimes even costing near nothing, as little work is required, according to people familiar with the matter.

Along with making leveraged loans for a buyout, banks also underwrite high-yield bonds to fund the deal. That business got banks $3.2 billion in fees last year, up about 14 percent from 2016.

Loan Obligations

Banks also landed $1.7 billion from structuring securities called collateralized loan obligations, which are the biggest buyers of the leveraged loans. Last year was a banner year for CLOs. Issuance of the securities eclipsed $100 billion, and may end up exceeding the $124 billion record set in 2014.

Banks can earn around 50 basis points and more for arranging a new-issue CLO, according to people familiar with the matter.

How long this boom may last is unclear. While the new U.S. tax plan cuts corporate taxes, it limits a key deduction on debt, making leveraged acquisitions potentially less appealing. And central banks are withdrawing liquidity programs that had propped up asset prices, according to Charles Peabody, a banking analyst at Compass Point Research & Trading.

“Banks are under tremendous pressure to find revenue growth so they’re taking increasing risk,” he said. Peabody suspects that 2018 will see the various economic trends come together in a way that could cause banks some pain.

To contact the reporter on this story: Sally Bakewell in New York at sbakewell1@bloomberg.net.

To contact the editors responsible for this story: Shannon D. Harrington at sharrington6@bloomberg.net, David Papadopoulos at papadopoulos@bloomberg.net, Larry Reibstein

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