Bridge Loans Put Banks in a Bind

Why JPMorgan, Citi and other big banks could be left high and dry after doling out billions to their lucrative private equity clients

by Steve Rosenbush

JPMorgan Chase CEO Jamie Dimon calls bridge loans "a bad financial policy," but adds, "that's the world we live in." Mike Appleton/Bloomberg

As the leveraged buyout boom peaked earlier this year, large banks such as Citigroup (C) and JPMorgan Chase (JPM) indulged powerful private equity clients by granting them temporary equity, or bridge loans, to help fund the monster deals.

Bridge loans facilitated massive transactions such as the $44 billion takeover of Texas utility TXU (TXU) by Kohlberg, Kravis, Roberts and others, and the KKR-led $28 billion buyout of information company First Data (FDC). The idea was simple: The banks would take an equity stake in huge buyouts to help clear the transactions, and then sell them quickly after the deals closed. Now, however, that arrangement has become virtually impossible. The worldwide crisis in the credit markets, which began with rising defaults in the subprime lending arena, has now spilled into higher-grade corporate debt as well as equities (see BusinessWeek.com, 8/2/07, "The Pain Moves Beyond Subprime"). Last week, in response to a liquidity crunch, central bankers around the world injected billions of dollars into the financial system.

Credit valuations have fallen across the board since late July and that could force the banks to sell their bridge loans at a loss or keep them on their books, raising risk and tying up billions in capital (see BusinessWeek.com, 7/19/07, "Is the End of the M&A Boom at Hand").

The Idea Behind Bridge Loans

The banks readily concede that bridge loans represent some of their biggest fiscal risks. Among those leading the jeers: Jamie Dimon, chief executive officer of JPMorgan Chase, one of the banks that delved deeply into such financing. "I think equity bridges are a terrible idea," Dimon said in a late July conference call with analysts. "I think they're bad. I think they're a bad financial policy. I don't think they're good for the banks. I don't think they're good for the private equity guys. So I hope they go the way of the dinosaur because they're basically a one-sided put on our balance sheet."

In theory, a bridge loan is similar to a home buyer who takes out a short-term loan to cover the down payment, which he plans to repay as soon as he sells his current home. But what if the current home can't be resold? The lender can try to resell the loan, but as current market conditions suggest, that isn't always possible. Banks now face a similar quandary. They lent private equity firms hundreds of millions of dollars to use as equity in the buyouts. The bridge loans were supposed to be repaid as soon as the buyout firms found other investors who wanted an equity stake in the leveraged buyouts. But as market conditions have tightened, private equity firms have found it difficult to find investors to take some of the bridge loans from the banks. The banks can keep trying to sell the loans, a tough bet in the current market. Or they can keep them on their books—and possibly have to write down their value.

So why would a banker agree to such a deal? As a favor to big private equity firms, which have been among the banks' most lucrative customers, generating a record 22% of investment banking revenue over the past year, according to researcher Dealogic. And until the abrupt turn in the credit market, it seemed like the bridge loans might easily be sold. All told, banks are on the hook for billions in bridge loans, although Citi, JPMorgan and others decline to reveal their precise exposure.