Commercial Banks and Bridge Loans

Yesterday's Wall Street Journal ran an article in the Money & Investing Section which focused on Chase's, Citi's and BofA's exposures to bridge loans to private equity firms.

According to the article, the three banks have $33B in bridge loans outstanding to private equity groups for deals yet to be refinanced with longer-term money. Last year, these loans totaled only $12.9B among the three banks.

Although some analysts contend that these banks are so diversified that there is negligible risk, I am not so sure. First Boston was finally shoved into the arms of Credit Suisse over its losses in a bridge loan for the now-infamous Ohio Mattress deal in 1989. At the time, a liquidity crunch cratered the junk bond market, causing the Ohio Mattress loans to lose most of their value, along with the holder of those loans, First Boston.

True, a liquidity pullback might not destroy the balance sheets of any of the three commercial banks. But it will certainly put a dent in them, and damage earnings for the year. For example, if Chase owned one-third of the bridge loans outstanding, or $11B, that would be just shy of Chase's recent $15B full-year NIAT figure.

That sort of loss can certainly retard growth in the financial services sector for a time. Despite the hoopla over sub-prime mortgages, I would venture to guess that this private equity-related bridge loan situation is a greater source of risk to these three banks. As the banks have supplied bridge loans, their investment banking units are sure to be wanting to participate in private equity deals, too, as John Mack, CEO of Morgan Stanley, has gone on record as wanting to do. That sort of activity will add equity price risk to the mix, and lodge the total financial risk of such a deal with a commercial bank.

With private equity having become such a driver of merger and acquisition activity of late, I sense that this will be the area that sees the next large asset meltdown for the large commercial banks.