Banks are increasingly turning down companies seeking financing to pay for debt-

Question

Banks are increasingly turning down companies seeking financing to pay for debt-laden takeovers after the recent market rout left them saddled with debt from earlier deals. Credit Suisse Group AG, Jefferies Group LLC and Wells Fargo & Co. are among the firms turning down new requests for financing-typically from low-rated companies-as they retreat from the lucrative but risky business of backing debt-heavy buyouts (WSJ, M&A Bankers Saying No to MOre Junk, March 21, 2016).

Questions: 1. Why do you think investors have lost their appetite for the riskiest securities?

2. Why doesn't the interest rate on these riskiest loans simply rise to the point that these risk-averse investors buy them?

3. If debt financing for takeovers isn't possible, why don't acquirers issue equity to finance the deals instead?

Explanation / Answer

1) Investors have lost their appetite for the riskiest securities because even though it is a high risk ,high returns game , investors have seen in past that most of the debt laden takeovers have failed and have not provided them the intended returns. This has become more evident after the recent market rout.

2) For increasing the interest rates on these loans, the banks should do an accurate market data analysis of future market trends to predict the demand of loans as per different interest rate. Since the market is very fluctuating and volatile , it is almost impossible to accurately predict future demands.

3) As per Pecking order theory, the firms should first resort to debt financing . If the debt financing is not available , then only they should go for equity financing. The problem with equity financing is that, the firms and retail investers themselves are not very much confident about the success of risky takeover which might result in undersubscription in market.

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