By Lananh Nguyen, Saeed Azhar and Shankar Ramakrishnan
NEW YORK (Reuters) -Some of the banks that lent Elon Musk $13 billion to buy Twitter are preparing to book losses on the loans this quarter, but they are likely to do so in a way that it does not become a major drag on their earnings, according to three sources with direct knowledge of the situation.
Banks typically sell such loans to investors at the time of the deal. But Twitter's lenders, led by Morgan Stanley (NYSE:MS), could face billions of dollars in losses if they tried to do so now, as investors shy away from buying risky debt during a period of economic uncertainty, market participants said. In addition, Twitter has seen advertisers flee amid worries about Musk's approach to policing tweets, hitting revenues and its ability to pay the interest on the debt.
Banks still have to mark the loan to its market value on their books and set aside funds for losses that are reported in quarterly results. In the absence of a price determined by actual sales of the debt, however, each bank can decide how much to write it down based on its market checks and judgment, according to the three sources who are familiar with the process of determining the value of such loans.
The biggest chunk of the debt -- $10 billion worth of loans secured by Twitter's assets -- might have to be written down by as much as 20%, one of the sources said. The hit on the loan, distributed among seven banks, could probably be managed by most of the firms without creating a significant hit to profits, the source added.
Another one of the three sources with direct knowledge of the matter estimated that some banks might only take a 5% to 10% writedown on the secured portion of the loan.
The deliberations of how some of these banks are thinking about accounting for these losses have not been previously reported. They come as Wall Street banks are bracing for lower fourth-quarter earnings due to a slump in investment banking revenue and a rise in loan-loss reserves amid a weakening global economy.
Three banking industry sources said the remaining $3 billion, which is unsecured, could lead to steeper losses for the seven Twitter banks. Reuters could not determine how much the banks were planning to write down the unsecured portion of the debt.
The lenders have considered replacing the unsecured part of the debt with a loan to Musk backed by his shares of Tesla (NASDAQ:TSLA) Inc, the electric carmaker, one of the sources familiar with the talks said. Musk, however, has said it is best to avoid such loans in the current macroeconomic environment. Bloomberg previously reported the margin loan possibility.
Besides Morgan Stanley, the syndicate includes Bank of America Corp (NYSE:BAC), Barclays (LON:BARC) Plc, Mitsubishi UFJ (NYSE:MUFG) Financial Group Inc, BNP Paribas (OTC:BNPQY) SA, Mizuho Financial Group Inc and Societe Generale (OTC:SCGLY) SA.
SocGen, Musk and representatives for Twitter did not respond to emailed requests for comment. Representatives from the other banks declined to comment.
ACCOUNTING FLEXIBILITY
Under accounting standards, the banks must mark the loan to its market value when some of them report earnings for the fourth quarter in January, several bankers and accountants said.
But with market activity coming to a standstill, the banks have a fair amount of flexibility on how to value them, which means each one could value them differently. They also have leeway on how to report any write downs and the time they take to sell the debt. Leveraged loan deals after the 2008 financial crisis took years to clear.
Each bank would make market checks with two or three potential buyers to arrive at a value of the loans, which an auditor would have to agree with, one of the three sources said.
The person, who is familiar with the thinking of one of the banks in the lending syndicate, added that some lenders are likely to take a smaller hit initially and write it down over time if valuations keep getting worse.
Projected losses could also be divided between investment banking and trading divisions, making it small enough that it doesn't have to be disclosed separately, one of the sources said. Any writedowns would probably be broken into chunks and spread over several months, reducing the hit to earnings in any one quarter, two of the sources with direct knowledge of the matter said.
Some market participants expect the losses from the debt to be significant unless market conditions improve. Two of the banking industry sources said if the banks tried to sell the loans now, they would not get more than 60 cents to the dollar on the secured bond and an even lower price on the unsecured portion. That would add up to billions of dollars in losses for the syndicate as a whole.
In September, Wall Street lenders led by Bank of America suffered a $700 million loss on the sale of about $4.55 billion in debt backing the leveraged buyout of business software company Citrix Systems Inc (NASDAQ:CTXS).
Some $35 billion to $40 billion of such loans are stuck on banks' books, according to two fixed income bankers.
Twitter's bankers, however, are more sanguine. "I wouldn't bet against Elon Musk," Morgan Stanley Chief Executive James Gorman said in an interview at Reuters NEXT earlier this month. "We don't get behind that kind of business and that kind of opportunity unless we believe it is real."