WSJ mentions infamous 1989 / "Burning Bed" / First Boston Corp / bridge loan "mess" .....................
May 18, 2007
Fed, Other Regulators Turn Attention to Risk In Banks' LBO Lending
By GREG IP
The Federal Reserve and other regulators are taking a closer look at the risks banks may be taking on in financing the boom in leveraged buyouts.
Banks have been major players in the surge of takeovers, both as lenders to and investors in buyout targets. As yet, there is little sign that this activity poses a threat to the banks' health. They have strong capital bases thanks to years of strong profits.
But a buoyant financing environment has led investors and lenders to accept declining returns on all sorts of risky assets. Regulators see signs of that in LBO lending, particularly in what is known as "bridge" financing, or the temporary credit that serves as a stopgap between the buyout and longer-term financing.
LBO loan volume hit $121 billion last year, compared with $31 billion in 1998, the peak of the previous cycle, according to Standard & Poor's Leveraged Commentary & Data. Volume this year has reached $88 billion, more than double the year-earlier period. Meanwhile, interest-rate spreads have fallen to their lowest levels ever, and loan restrictions have been loosened.
"There are some significant risks associated with the financing of private equity, including bridge loans, [and] we are looking at that," Federal Reserve Chairman Ben Bernanke said in response to questions at a Chicago conference yesterday. "I urge banks to closely evaluate the risk that they're taking not only in the context of a highly liquid, benign financial environment, but in one that might conceivably be less liquid and benign."
And speaking Tuesday in Sea Island, Ga., Federal Reserve Bank of New York President Timothy Geithner said, "We are...looking carefully at...the management of the bridge exposures institutions run in leveraged lending, leveraged buyout and merger-and-acquisition financing."
Mr. Geithner characterized this as part of a broader look at how the financial system is dealing with risk.
As yet, there is no sign regulators plan formal guidance such as they issued on commercial bank lending last year. However, the Office of the Comptroller of the Currency, which regulates nationally chartered banks, has launched a special study of leveraged lending, or loans to heavily indebted companies, including private-equity buyouts, "to look specifically at what changes in underwriting practices we're seeing," said Kathy Dick, deputy comptroller. She said she expects results by August.
The leading arrangers of such loans are J.P. Morgan Chase & Co., Bank of America Corp., and Citigroup Inc. Their exposure is far smaller than the total because they typically "syndicate" the loans, that is parcel out pieces to other banks, institutional investors, and special-purpose entities called "collateralized debt obligations." What they keep, they often hedge with credit-default swaps.
But banks are still exposed to default in the period before they have syndicated or hedged a loan. Even a short-term bridge loan exposes the lender to the risk that the borrower won't be able to find longer-term financing, or will default. One worry for regulators is that an abrupt deterioration in the markets could suddenly leave many banks with long-term exposure they hadn't counted on.
In a famous event dubbed the "Burning Bed," First Boston Corp. in 1989 made a $457 million bridge loan to the purchasers of Ohio Mattress. When the junk-bond market collapsed soon afterward, First Boston couldn't refinance the loan and ended up owning most of Ohio Mattress. Credit Suisse had to inject additional capital into First Boston, culminating in a full takeover.
Private-equity financing has been lucrative for banks, but even they are on the lookout for excess.
In a speech to the Swiss-American Chamber of Commerce in Zurich last week, Kenneth Lewis, the chief executive of Bank of America, which participated in seven of last year's 15 largest LBOs, said, "There is tremendous value in being able to provide a strong balance sheet to arrange large, complex financial transactions."
But in answer to a question about private equity afterward, he said, according to Bloomberg News: "We are close to a time when we'll look back and say we did some stupid things....We need a little more sanity in a period in which everyone feels invincible and thinks this is different."
--Valerie Bauerlein contributed to this article.
Write to Greg Ip at greg.ip@wsj.com
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