Jamie Dimon Says Banks Getting Indigestion From LBO Debt

Jamie Dimon, CEO of JP Morgan, fesses up that commercial banks like his have overdone it on LBO debt and are likely to take writedowns. At this point, this statement is no revelation. The main point of Dimon’s remarks is to reassure investors that the prospective losses are not significant relative to JP Morgan’s capital base.

However, one comment from the Bloomberg story stood out:

It’s “kind of silly to take that kind of downside risk and none of the upside potential,” Dimon said. “I hope they go the way of the dinosaur.”

Huh? Dimon acts like the banks are passive order takers (which in fact they may be). Hasn’t he heard of the word “no”? No one is holding a gun to his head to do these deals.

From Bloomberg:

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said demand for leveraged buyout debt is drying up and banks may be left holding more loans that they can’t sell.

There is “kind of a little freeze in the marketplace,” Dimon said on a conference call with investors to discuss the New York-based bank’s second-quarter earnings. “If you see this continue you will see the Street taking on a lot of bridge loans and more aggressive repricing of those things.”

JPMorgan, the third-largest U.S. bank, is among lenders that have been saddled with at least $11 billion of high-yield bonds and loans they haven’t been able to readily sell, data compiled by Bear Stearns Cos. analysts show. Investors have balked at the increasing amounts of debt being taken on for LBOs.

In most deals, investment banks promise to provide loans to the buyer. They then seek other lenders to take pieces of the loans and find buyers for bonds. When buyers vanish, the banks must either buy the bonds themselves or provide a bridge loan to the borrower, tying up capital that would otherwise be used to finance more deals. The banks typically parcel out portions of bridge loans to reduce their risk.

“Yes we have some writedowns,” Dimon said. “There are some hung bridges, again nothing on our balance sheet we are particularly concerned about.”

Lenders have committed to about $100 billion of high-yield bond or bridge financings and $200 billion of loans, according to Dimon.

Equity Bridges

As demand surged for bonds and loans generated by leveraged buyouts, private equity firms such as Kohlberg Kravis Roberts & Co. and Blackstone Group LP were able to extract concessions. Banks agreed to give the buyout firms so-called equity bridge loans to finance their takeovers, a practice that is a “terrible idea,” Dimon said today.

In equity bridges, banks take a stake in the target company, reducing the amount of money required from buyout firms. After the deal is completed, banks sell their holdings, often to limited partners in the private equity firm’s funds such as pension funds, university endowments and wealthy individuals.

It’s “kind of silly to take that kind of downside risk and none of the upside potential,” Dimon said. “I hope they go the way of the dinosaur.”

A put option gives the buyer the right to sell a specified quantity of a security by a certain date. The holder hopes the security’s price will tumble.

TXU Bridge

JPMorgan agreed to provide a $500 million equity bridge loan to help finance Dallas-based power producer TXU Corp.’s $45 billion purchase by a group including KKR and TPG Inc., according to regulatory filings. Morgan Stanley and Citigroup Inc., both based in New York, also promised to contribute $500 million each of equity bridge financing for the takeover.

JPMorgan said today that second-quarter profit rose 20 percent to $4.23 billion on record investment-banking fees and gains from private-equity holdings.

High-yield, or junk, debt is rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s.

Dimon said the bank is comfortable with its risk from lending commitments to private equity firms even though firms have been unable to sell some of the debt to investors.

JPMorgan failed to sell $1.15 billion of bonds for Memphis, Tennessee-based ServiceMaster Co. on July 3. The banks provided ServiceMaster, the maker of TruGreen and Terminix lawn-care products, with a bridge loan to make up for the failed bond sale. ServiceMaster is being bought by private equity firm Clayton Dubilier & Rice Inc. for $4.7 billion.

Some of the private equity firms “are trying to be as flexible as they can” and “some are being much tougher,” Dimon said. “With the idea that the bank signed up and that’s that. They get paid to take that risk and they are taking that risk.”

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