NEW YORK (Reuters) - Banks that offered cheap short-term financing for private equity deals made hay for years, but some of those loans are now costing lenders more than they expected.
Citigroup (C.N) said on Friday it was stuck at the end of June with four “bridge loans,” or short term loans, it was having trouble selling to other institutions.
And JPMorgan Chase & Co (JPM.N) Chief Executive Jamie Dimon said on Wednesday it might have to set aside more money for losses on bridge loans in the future.
Banks make bridge loans to private equity firms, usually with the hope of winning lucrative underwriting, lending and advisory business in the future.
Lenders usually hope to share the risk for these loans with other banks and institutions, but with current trouble in the junk bond and leveraged loan markets, that has become difficult.
“The whole idea is to get in there, make the loan, spread around your risk on the loan, and not be the one left holding the bag,” said Carl Salvato, portfolio manager at Great Companies LLC in Tampa, Florida, which owns Citi shares.
These loans help bring in business and ending them entirely could cut into a bank’s lending, underwriting and advisory revenues, analysts said.
Citigroup’s Chief Financial Officer, Gary Crittenden, said on a conference call he was confident the bank could get other institutions to share risk on the four loans at the right price.
But the delays and modest write-downs that resulted from not being able to sell these deals in the syndicated loan market had a small impact on revenue.
The entire leveraged loan business accounted for about 5 percent of Citi’s securities and banking revenue in 2006, Crittenden said.
The effect of bridge loans on third quarter results could be larger, Crittenden said, adding it is difficult to determine what the impact would be, if any.
“Anybody who would be making that kind of a forecast would be trying to rely on things that simply have not yet happened,” he said.
The risk connected to bridge loans can be high. If a bank is unable to share the exposure, or any permanent financing that replaces these loans, it can be left holding them.
That is one reason why JPMorgan Chase Chief Executive Jamie Dimon earlier this week called equity bridge loans “a terrible idea.”
“I hope they go the way of the dinosaur,” he added.
Equity bridge loans help finance the equity portion of a leveraged buyout.
Offloading risk is increasingly difficult as more lenders and investors become picky about terms on loans and bonds.
UK health and beauty retailer Alliance Boots is revising terms on 9 billion pounds ($18.5 billion) of bank debt backing its buyout, a debt arranger said on Friday.
Bridge loans are hard to love, but they’re also hard for banks to say “no” to.
Leveraged buyout firms have become key players in mergers and acquisitions. According to Dealogic, private equity firms announced $745.82 billion of deals last year, or nearly 20 percent of mergers.
That translated to big money for Wall Street. Private equity firms paid out some $6.1 billion in fees for bonds and loan underwriting globally in 2006, according to Dealogic.
“It’s difficult for banks to say they do not want to do it if they want to stay in the game,” said Michael Holland, principal at Holland & Co in New York, which owns Citi and JPMorgan shares.
“Products like these don’t usually become extinct until someone gets hurt very badly.”
Reporting by Dan Wilchins