Bridge Loans Put Banks in a Bind

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JPMorgan and Citi declined to comment beyond their previous public statements. Bank of America (BAC) officials referred inquiries to the company's second-quarter conference call on July 19, during which executives declined to specify the bank's exposure.

A Hindrance to Risk Diversification

Dimon said equity bridges are particularly risky, even compared to highly leveraged loans. That's because equity bridges are made with little or nothing in the way of seniority or collateral, which is a crucial issue for bankers and investors in bank debt (see BusinessWeek.com, 7/30/07, "The Deep Risks of 'Asset-Light' Debt"). "We're involved in a couple, and that's life. That's the world we live in," Dimon told analysts. He refused to reveal details of the loans or their values, but said he was "comfortable" holding the hung deals on the bank's books, since risks notwithstanding, they would probably turn out to be profitable.

JPMorgan isn't alone. Citi and Bank of America are among other big corporate lenders. Citi's chief financial officer, Gary Crittenden, said on a July 20 conference call that the bank had committed to four LBO financings that couldn't be sold—and that other such deals would occur in the future. The loans in question are so-called covenant light loans, which place few restrictions on borrowers and are nearly impossible to sell in the secondary market. The huge financing for First Data includes $16 billion in covenant light debt, which has yet to be syndicated, according to Dealogic. Citi, Credit Suisse (CS), Deutsche Bank (DB) and others are taking the lead on that loan.

Banks typically sell, or syndicate, their loans to other banks and investors. Hung loans and equity bridges that can't be sold to secondary investors make it hard to spread the risk. "It's a matter of concentration. Banks are supposed to be in the business of diversifying risk," says Tanya Azarchs, a bank analyst with Standard & Poor's, which, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP). "Hung loans and bridge loans, especially equity bridges, create much more risk for banks."

Want to Buy a Bridge?

So how much will the banks suffer? The S&P banking index has fallen 10% during the last few weeks, because investors fear that the earnings will slow and existing loans that can't be sold will fall in price or default. "There could be write-offs," says Azarchs, adding that it's too early to calculate their value.

For its part, Citi has provided bridge financing for First Data and other deals. "In a small subset of these transactions we have equity bridge commitments, which we take on selectively for top-tier clients in connection with our leveraged financing," Crittenden said. Citi also has pledged bridge financing for other buyouts such as TXU, and the $28 billion buyout of wireless carrier Alltel (AT) by Goldman Sachs (GS) and Texas Pacific Group. Crittenden said he believed the loans would eventually sell after they are repriced.

Still, that could take a while. Investors have all but stopped buying debt, because prices are falling and better deals could emerge by waiting. But if the economy takes a turn for the worse and questions of fundamental credit quality about these loans are raised, the banks may find themselves stuck on a shaky bridge.

Rosenbush is a senior writer for BusinessWeek.com in New York.