Investment banks are desperate to conserve every penny and the battle over Clear Channel shows how far they are ready to go to avoid shelling out.

The $20 billion (£10 billion) deal to acquire the American radio and billboard advertising giant was signed in May last year, at the pinnacle of the M&A bull market. The banks drooled over the two private equity bidders, Bain Capital and Thomas H Lee Partners, and aggressively competed for a piece of what was one of the year’s hottest buyouts.

When the consortium’s first offer of $37.60 a share fell short, it was the banks who persuaded the bidders to come back with more and funded the majority of the raised $39 bid. To miss out on the chance to finance such a leveraged gem was a sackable offence and in the end the bidding consortium managed to secure 87 per cent of the purchase price in cheap debt financing. The consortium’s equity contribution, in line with the vogue back then, was minuscule.

Fast foward to December and the banks are starting to get cold feet. They warn Bain and Tommy Lee that they are now sitting on $1.5 billion of potential writedowns. By January that figure has ballooned to $2.7 billion. But apart from a few small tweaks, the private equity firms flatly refuse to change the debt terms. And with written commitments and importantly, no material adverse change clause (MAC) that might allow the banks to wriggle free, they sit back, comfortable in the knowledge that there is little the banks can do.

In February the banks come up with a new wheeze – seizing on complex restrictions on certain lines of revolving credit that make it impossible for Bain and Tommy Lee to repay Clear Channel’s existing roughly $4 billion debt pile that comes due in 2011. Without the ability to use the cash in the short-term, “the debt deal would blow up” as one source close to the talks said yesterday. The banks hadn’t refused to finance the deal per se, but their actions meant it was effectively dead.

On the face of it, there is an argument that says it is absolutely in private equity’s interests to shut this deal down. Clear Channel’s share price has tumbled since the deal was announced and the US is teetering on the brink of a recession which can’t be good for a business reliant upon advertising. The lawsuits are surely just a way of making the banks cough up their fair share of the $600 million break fee. Yet one look at the maths and the banks’ argument does not appear to hold water.

Bain and Tommy Lee stood to pay only 13 per cent of the total deal price in cash. The small sliver of equity relative to the mountain of debt means that only a tiny improvement in Clear Channel’s business would produce huge returns while the risk of the equity being wiped out, if market conditions deteriorate further, is minimal. It is also hard to believe they would have agreed to a financing package that restricted their ability to pay off short-term debt.

The severity of yesterday’s lawsuits is also key. It’s not just private equity suing, but Clear Channel itself. And they’re not just suing for breach of contract, they’re claiming “tortious interference” and fraud to boot. Put simply, they’re going after the banks with everything they can muster.

The worry is that the financiers, led by Citigroup and Deutsche Bank, will try to do the same on other uncompleted deals. The obvious target is BCE, the massive $34.1 billion Canadian telecoms deal that was signed, like Clear Channel, at the height of the boom.

So far, executives have said the deal is on track but one look at the debt providers – Citigroup and Deutsche Bank – and it is easy to see why investors are becoming nervous.

siobhan.kennedy@thetimes.co.uk

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