Wall Street banks have been left hanging in a critical market

The credit markets took a turn for the worst late last year.

The high-yield market blew out over the course of a couple of weeks in December, with the impact of that sell-off likely to show up in fourth quarter bank earnings.

The weakening of the credit markets impacts profits from trading, as banks face choppy conditions, debt underwriting and the value of loans carried on the banks’ books.

In particular, sharp moves have the potential to lead to so-called ‘hung’ leverage loans.

Hung deals typically occur where a bank provides bridge financing on an acquisition, with a view to that loan being refinanced in the bond market at a later date. If yields spike between the loan being made and the ensuing bond deal, banks can lose out as the bonds have to be sold at a discount to attract investor interest.

Banks were having difficulty selling leveraged loans as far back as October.

The Financial Times then highlighted the risk of these kinds of deals back in November, before the market deteriorated further in December.

And in a note Tuesday on Goldman Sachs and Morgan Stanley, Credit Suisse analyst Christian Bolu again highlighted the risk posed by ‘hung’ leverage loans. He said the upcoming Dell/EMC financing would provide a key test for the high yield markets, and its ability to absorb lots of paper.

He said (emphasis ours):

Looking forward, the financing of the $67Bn Dell/EMC merger should provide a real life test of the health of high yield financing markets. Press reports suggest required financing will be ~$50 Bn with a post-merger leverage of 5-6x EBITDA and financed through 8 banks (GS is part of the syndicate) via a combination of debt issuance and bank loans.

Here is a list of the deals that could be impacted from Credit Suisse:

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