Bank Of England Warns Of Looming Private Equity Crash
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Hundreds of U.K. companies may soon be at risk of defaulting due to highly-leveraged buyouts made by private equity funds prior to the 2008 financial crisis, warned the Bank of England on Thursday, with the entire U.K. financial system believed to face massive instability unless the debt can be refinanced or restructured.
Hundreds of U.K. companies may soon be at risk of defaulting due to highly-leveraged buyouts made by private equity funds prior to the 2008 financial crisis, warned the Bank of England on Thursday, with the entire U.K. financial system believed to face massive instability unless the debt can be refinanced or restructured.
“In the mid-2000s, there was a dramatic increase in acquisitions of UK companies by private equity funds,” the Bank said, in its latest quarterly bulletin published on Thursday. “The resulting increase in indebtedness makes those companies more susceptible to default, exposing their lenders to potential losses.”
[quote]”Many of these buyouts, especially the larger ones, were highly leveraged and the increased indebtedness of such companies poses a risk to the stability of the financial system. This risk is compounded by the need for companies to refinance debt maturing over the next few years in an environment of much tighter credit conditions,” the Bank added.[/quote]Under a new regulatory framework that will come into effect in April 2013, the Bank said that it would use its new role as a financial watchdog to monitor future private equity deals for “episodes of exuberance”, so as to prevent a similar event from happening again.
However, the Bank urged private equity funds, for the moment at least, to prevent a possible financial crash, by restructuring any of their presently owned companies in difficulty, while holding out on highly leverage buyouts in the near future.
“At the beginning of 2007, 14,000 firms were held in private equity ownership worldwide, compared to fewer than 5,000 in the year 2000 and fewer than 2,000 in the mid-1990s. In the United Kingdom the private equity owned sector amounts to around 5 percent of the corporate sector by total assets but accounts for a larger proportion of UK corporate sector debt — around 8 percent.”
“Many investors report that the buyout market is showing now renewed signs of activity, (even though) the market in the United Kingdom remains much less active than before 2008… in the United Kingdom — private equity firms taking ownership of insolvent companies has accounted for 11 percent of buyout activity in 2012, compared to 3 percent of total private equity sponsored buyouts in 2011.”
“One risk to the UK financial system from these debt levels is the heightened fragility of the corporate sector. Specifically, higher debt levels could make companies less likely to undertake long-term investment if that investment is crowded out by the costs of servicing debt.”
[quote]“There is a potential role for private equity to play in promoting recovery in a downswing, in particular at the current juncture, by restructuring companies in difficulty,” the Bank added.[/quote]Related: What Is Private Equity?
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The study cited the case of Royal Bank of Scotland, now 83 percent owned by the taxpayer after being rescued from collapse by the Treasury in October 2008. An aggressive expansion into leveraged finance was an important factor in RBS’s credit losses, the Bank said.
The Bank however admitted that there is still no clear evidence yet of a higher default rate among private equity owned companies.
“A complete picture will not become clear until more investments from the mid-2000s have been exited,” the Bank said. Nonetheless, a refinancing challenge may occur in 2014, it added, because the peak in debt issuance was in 2007 and the average maturity of leveraged buyout debt is seven years.
Proponents of private equity funds say that buyouts help to make companies more efficient by spurring management to provide regular interest payments on the debt. Still, the Bank said that they would continue to monitor potential risks to financial stability from private equity sponsored activity.
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