Monday, August 13, 2007

Bridges, Squares

The current distress in credit markets in the US and elsewhere has been reasonably kind to Mrs. Cutesome, although she is likely very soon to go from being a cute leveraged finance expert to a cute workouts and restructurings expert. Me? Not so much. The market's been busy, and there's an outside chance that we could get armageddon for all borrowers rather this flight to quality that everyone keeps going on about (What is quality? Whatever said banker happens to have on his books. Heh)

But what we're still missing, amidst the discussion of how home loans work, is some decent discussion of how corporate finance works. So we know that jumbling dodgy home loans together and selling them on to investors can lead to these investors holding dodgy securities. We know that this has made investors in other kinds of debt more nervous.

But we don't know how this will play out. More importantly, mainstream media knowledge of the workings of leveraged finance is pretty slim. Reporters can write a story pretty easily about how buyers can't get debt and they can suggest that debt will be more expensive. Those with advanced ninja private equity skills might suggest that covenant lite loans will become more covenant heavy.

At this point we start wading off into crazy-land. Sometimes covenant-lite means not monitoring debt-cashflow measures, the sort of oversight most frequently mentioned in discussions of covenants, but it also covers a host of other restrictions, including those on asset disposals and the ability of buyers to extract cash from their purchases.

The other measure is more simple - how much money is the buyer putting down? This is one area where discussions of mortgages and leveraged buy-outs proceed on similar tracks. If a buyer puts more equity into the deal, and since if a deal goes bad, this equity gets repaid after banks recover their money, deals with a higher proportion of equity tend to be less risky for banks. they tend to mean lower returns for borrowers, but then this is the same for a mortgage.

So now, we've established the difference between equity and debt, we'd hope that the difference between an equity bridge loan and a debt bridge loan is clear. It's not unfortunately, since writers tend to conflate the two. The huge majority of hung loans, or pier loans, on banks' balance sheets are meant to be repaid with longer-term debt. It's not as if private equity funds are short of capital, and while they may ask for their banks to tide them over with an equity bridge until the deal's close, they're usually good for the repayment - indeed some loans will come with a call on the cash in the fund.

I wouldn't call them risk-free, though, or particularly good business for the backs, since they're essentially unsecured "corporate" lending to the funds at low margins. Which was what Jamie Dimon, the CEO of JPMorgan, was talking about in the speech quoted in this Businessweek article:

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."

The article follows by explaining what equity bridges are, and uses the same perfectly reasonable analogy to borrowing for a down payment that I might. But I keep getting the feeling that the author is not aware that there are two types of bridges, and that since the banks won't tell him what types of exposure they have, he's still none the wiser. But debt and equity bridges have very different types of risk, and I could be wrong when I say that private equity funds are good for them.

But I'm absolutely certain that these bridge loans are not the ones clogging up banks' balance sheets. Its debt debt, bridges to a long-term financing that can no longer be assembled. It's a horrible drag on their earnings, but not toxic waste.


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