Many believed that the M&As during the 1980s were largely overpriced and overleveraged, and junk bond or high-yield financing was considered unlikely to recover from the pummeling it had taken at the end of the decade. Consequently, many assumed that takeovers would not return to their levels of the late 1980s.
Although M&A activity did diminish during the 1990 recession, the number of transactions and the dollar volume rebounded sharply beginning in 1992. The longest economic expansion and stock market boom in U.S. history, uninterrupted by recession, was powered by a combination of the information technology revolution, continued deregulation, reductions in trade barriers, and the global trend toward privatization. Both the dollar volume and number of transactions continued to set records through the end of the 1990s before contracting sharply when the Internet bubble burst, a recession hit the United States in 2001, and global growth weakened.
U.S. financial markets during this sixth wave, especially from 2005 through 2007, were characterized by an explosion of highly leveraged buyouts and private equity investments (i.e., takeovers financed by limited partnerships) and the proliferation of complex securities collateralized by pools of debt and loan obligations of varying levels of risk.
Much of the financing of these transactions, as well as mortgage-backed security issues, took the form of syndicated debt (i.e., debt purchased by underwriters for resale to the investing public). The syndication process disperses such debt among many different investors.
The issuers of the debt discharge much of the responsibility for the loans to others (except where investors have recourse to the originators if default occurs with in a stipulated time). Under such circumstances, lenders have an incentive to increase the volume of lending to generate fee income by reducing their underwriting standards to accept riskier loans. After such loans are sold to others, loan originators are likely to reduce their monitoring of them. These practices, coupled with exceedingly low interest rates made possible by a world awash in liquidity, contributed to excessive lending and encouraged acquirers to overpay significantly for target firms.
Because it is difficult to determine the ultimate holders of the debt after it is sold, declining home prices and a relatively few highly publicized defaults in 2007 triggered concerns among lenders that the market value of their assets was actually well below the value listed on their balance sheets. Subsequent write d owns in the value of these assets reduced bank capital. Regulators require banks to maintain certain capital-to-asset ratios.
To restore these ratios to a level comfortably above regulatory requirements, lenders restricted new lending. Bank lending continued to lag, despite efforts by the Federal Reserve to increase sharply the amount of liquidity in the banking system by directly acquiring bank assets and expanding the types of financial services firms that could borrow from the central bank, or by the U.S. Treasury’s direct investment in selected commercial banks and other financial institutions. Thus, the repackaging and sale of debt in many different forms contributed to instability in the financial markets in 2008. The limitations of credit availability affected not only the ability of private equity and hedge funds to finance new or refinance existing transactions, but also limited the ability of other businesses to fund their normal operations. Compounded by rapidly escalating oil prices in 2007 and the first half of 2008, these conditions contributed to the global economic slowdown in 2008 and 2009 and the concomitant slump in M&A transactions, particularly those that were highly leveraged.
Above picture provides the historical data underlying the trends in both global and U.S. merger and acquisition activity in recent years.