DealTalk: Concerns grow over risky equity bridge loans

By Michael Flaherty

NEW YORK (Reuters) - The recent popularity of a risky private equity financing agreement, known as an equity bridge loan, is raising concerns among analysts, regulators and even the bankers who arrange them.

Equity bridge loans allow private equity firms to get investment banks to share in the cash payment on deals. Such loans are great for buyout firms wanting to pursue takeovers without joining forces with competitors, but carry huge risk and skimpy pay-offs for the investment banks.

While this type of lending has been around for decades, the size and frequency of the loans has risen to the point where Goldman Sachs (GS.N: Quote, Profile, Research, Stock Buzz) has told its mergers and acquisitions staff to avoid them, according to a banker who works there. Goldman declined to comment about its policy.

The Ontario Teachers-Providence Equity Partners group pursuing Canadian telecoms group BCE Inc. (BCE.TO: Quote, Profile, Research, Stock Buzz) is asking investment banks to pony up a roughly $4 billion equity bridge, leaving the banks on the hook for about $800 million each, according to two people involved with the deal.

That's a staggering amount of exposure given that just last year, the equity bridge commitments for buyouts of media companies Univision and Clear Channel Communications Inc. (CCU.N: Quote, Profile, Research, Stock Buzz), which ranged from $100 million to $350 million, were deemed large, according to sources involved with the deals.

"Equity bridges are a really bad business," said an investment banker who arranges private equity deals. "You have a very small amount of reward for a huge risk. But people are doing them because it's forced on them in terms of being competitive. The pain is going to be immense if one of these bridges falls apart."

The best-case scenario is that the investment banks quickly sell the equity exposure to other buyers. But even then, banks typically earn only a 1.5 percent return on the loan. That means for risking $500 million, they earn just $7.5 million.

The worst case is that banks can't sell down the equity. Then they are left holding the bag, in some cases with hundreds of millions of dollars in exposure.