NEW YORK — Banks have largely stopped offering so-called equity bridges to private equity firms, ending a short-lived practice that facilitated some of the biggest corporate buyouts of all time.
The pullback is part of a broader tightening of financing terms that is expected to crimp the buyout boom that has driven stock markets and bank earnings steadily higher. Even with their newfound caution, however, banks like Citigroup Inc. (C) may have to take some lumps.
In what is considered one of the clearest signs of LBO excess, banks committed to put billions of dollars of presumably temporary equity into buyouts of companies such as TXU Corp. (TXU), First Data Corp. (FDC) and BCE Inc. (BCE). In five deals alone, banks agreed to provide about $6.7 billion in bridge equity. The high-risk service - typically provided by banks' capital markets arms rather than their in-house private equity funds - was aimed at winning fee-generating business from buyout firms that didn't want to put too much of their own money on the line in individual deals.
Banks offered these equity bridges with the understanding that the buyout firms would find investors to take over the banks' stakes after the deals closed. But banks are on the hook if investors balk at buying their positions - which bankers say is likely to happen with some pending deals. Drops in the value of the equity stakes have to be booked as losses, and unlike lenders, who earn interest and may be secured by company assets, equity holders have little recourse if things go badly wrong.
"That is risky, much more risky than a bank loan," said Steven Kaplan, a University of Chicago finance professor who studies private equity.
Deal Flow Could Slow
In addition, "hung" bridges can tie up a bank's capital for years, generating lower returns than the bank's trading businesses and limiting their ability to finance more deals.
"There's a capacity level within the firms," said Roger Lister, chief credit officer for U.S. financial institutions at bond-ratings agency DBRS. "If one deal doesn't go, now you're constrained on doing new deals."
Equity bridges started popping up late last year in deals such as Blackstone Group's (BX) $39 billion buyout of Equity Office Properties Trust, for which banks committed $3.5 billion. "In some cases, they have been instrumental in getting the deals done in the manner that they got done," said a senior capital markets executive at a Wall Street firm.
Bankers agree the practice made little sense. "It's silly to take that kind of downside risk and have none of the upside potential," James Dimon, chief executive of JPMorgan Chase & Co. (JPM), said on a conference call last week.
But that sentiment didn't stop JPMorgan, Citigroup and other banks from providing equity bridges in recent megadeals. The explanation lies in the significant clout that private equity firms wield on Wall Street, where banks crave the deep pools of underwriting and advisory fees that accompany leveraged buyouts.
Banks grudgingly provided bridge equity "because their best customers ask them to," said Robert J. Graves, co-head of the banking practice at law firm Jones Day. "It would be tough to envision credit people at a bank saying, 'This is a wonderful opportunity.'"
Banks Clamp Down
But the balance of power is shifting, largely due to a bond-market backlash that has doomed a number of recent debt offerings that were supposed to fund buyouts. That backlash already has left banks stuck with billions of dollars in hung bridge loans - commitments on the debt side that were intended to be temporary but which had to be funded when permanent financing couldn't be raised.
In the past four to six weeks, "the banks have really pushed back" when it comes to equity bridges, said a senior dealmaker at a top bank. "I actually think it's basically over." Officials at other major Wall Street firms agreed that banks have stopped issuing bridge equity, except in rare cases to favored clients.
Despite their role in financing blockbuster takeovers, equity bridges have stayed below the radar for many investors and analysts, as well as for financial data providers, which generally haven't been tracking the practice. The total volume of equity bridges that banks have committed is unknown.
Citigroup A Top Issuer
Based on a review of recent buyout agreements, Citigroup appears to have been among the top issuers of the bridges. The New York bank agreed to provide $300 million or more in bridge equity in some large deals, including the buyouts of Alltel Corp. (AT), Dollar General Corp., First Data and TXU.
Citigroup usually was one of a number of banks providing bridge equity in the deals, and some of the capital it committed apparently came from its internal private equity funds, which are equipped to hold the stakes for years. But industry observers said Citigroup was among the leaders in the equity bridge arena, as it strived for a larger share of the lucrative leveraged lending and debt underwriting businesses.
Some of the deals have encountered trouble. For example, Citigroup was one of at least five banks that agreed to provide bridge equity in Kohlberg Kravis Roberts & Co.'s acquisition of First Data, according to regulatory filings. KKR reportedly has struggled to find investors to kick in funds.
Bankers say a similar situation is likely to unfold in some pending deals.
"People are looking forward and saying, 'There are big equity checks in some of these, and I don't think there's going to be a market for that'," said the capital markets executive. "Right now there are no willing buyers," but he thinks that's probably a temporary phenomenon.
Citigroup's chief financial officer, Gary Crittenden, said in a conference call last week that the bank has agreed to provide bridge equity in a small number of deals that are expected to hit market turbulence. But he said Citigroup provided the bridges only "for top tier clients." Plus, the bank's massive balance sheet means it is less likely than its peers to be constrained if it gets stuck with equity stakes.
Some market observers doubt banks will get badly injured by exposure to equity bridges that lose value. But others note that the banks may end up holding some of the equity for several years, which means the consequences may not become apparent anytime soon. "Only time will tell," said the senior Wall Street dealmaker.
