The Secret Sauce for Private Equity Is Running Dry

As banks get burned from financing billion-dollar buyouts and pension funds grow impatient with private equity’s endless thirst for capital, skepticism is growing louder over the industry’s performance — and whether some of their daredevil deals could result in disastrous losses for their financiers.

The mood on Wall Street is quickly souring. Firms such as Bank of America Corp., Credit Suisse Group AG and Goldman Sachs Group Inc. are nursing more than $600 million of losses from a single deal: the $16.5 billion leveraged buyout of cloud computing giant Citrix Systems Inc. in January. Borrowing costs have surged since. Banks ended up selling $4 billion secured Citrix bonds at only 83.6 cents on the dollar, splashing red ink on their own balance sheets.

Already, one of the biggest lenders is retreating. Citigroup Inc. will slash its exposure to so-called subscription lines of credit, or short-term loans to private fund managers who use their investors’ capital commitment as collateral, to $20 billion from about $65 billion, the Financial Times reported.

For banks, subscription lines are safe but low margin, mainly used to cultivate relationships with private equity for more lucrative businesses, such as M&A fees. But for PE fund managers, this form of borrowing has become essential. It allows them to complete deals without having to knock on their investors’ doors each time cash is needed. After all, no one wants to be a nag, especially when money is tight.