Private Equity Crash Could Trigger Next Wave Of Financial Crisis, Bank Warns

[koala_bear]

http://www.guardian.co.uk/business/2013/mar/14/private-equity-financial-crisis-bank-of-england

The Bank of England warned on Thursday that the next phase of the UK's six-year financial and economic crisis may be triggered by the collapse of debt-laden companies bought by private equity firms in the boom years before the crash.

In its latest quarterly bulletin, Threadneedle Street said the need over the next year to refinance firms subject to heavily leveraged buyouts posed a systemic threat.

The Bank added that it would use its new role as the watchdog of the City to monitor private equity deals in future "episodes of exuberance" to prevent a repeat of the debt-driven takeover boom in the run-up to the banking crisis.

"In the mid-2000s, there was a dramatic increase in acquisitions of UK companies by private equity funds," the Bank said.

"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 – a risk that is compounded by the need for companies to refinance debt maturing over the next few years in an environment of much tighter credit conditions."

Noting that there had been a surge of private equity deals in the first six years of the last decade, the Bank said a feature of the investments had been the use of debt. Buyouts were typically financed by money borrowed from banks, with the debt becoming the liability of the purchased company.

There was evidence, it said, that private equity companies had been particular beneficiaries of "forbearance" by commercial banks – the tendency of lenders to go easy on borrowers for fear that they might go bust. But it said a refinancing challenge was looming in 2014, because the peak in debt issuance was in 2007 and the average maturity of leveraged buyout debt is seven years.

Deals became bigger and bigger as the decade wore on, and this trend coincided with a loosening of credit conditions by banks, which made debt finance even more attractive as they vied for business.

The study cited the case of Royal Bank of Scotland, now 83% 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, Threadneedle Street said.

Owners of private equity companies say the buyouts help to make companies more efficient by spurring management to provide regular interest payments on the debt.

But the Bank said there were also potential downsides to private equity, including the risk that the pressure for short-term returns would starve companies of long-term investment.

"A consequence of the increased use of debt financing on buyouts in the mid-2000s was that debt to earnings ratios, in particular on deals in excess of £100m, climbed to persistently high levels.

"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."

In a separate article in the bulletin, the Bank said it would expect to make a profit on the purchase of gilts under the £375bn QE programme unless the announcement that the scheme was to be reversed triggered a big rise in long-term interest rates.

The Bank has been making money on its gilt purchases since QE began in early 2009 because the price of government bonds has risen.

When the time comes for QE to be reversed, the Bank expects the fall in bond prices to push up yields – a measure of the cost of borrowing – on gilts.

Work by the Bank's economists has shown that the state would still make a small profit on QE if yields on 10-year gilts rose from 2% to 5% but there would be a £5bn loss if they increased to 6%.

Nothing particularly new for HPCers as we knew 2014 was going to be the peak year for refinancing both here and in the US (an not just for PE lending either), but always good to have a MSM article to spread the message. The real entertainment comes when the banks find the firm can't be refinanced and they have ignored the covenants if it suited them in the past. Also plenty of deceased or Zombie banks since 7 years ago.

Plenty of interest in the actual BoE report too.

http://www.bankofengland.co.uk/publications/Pages/quarterlybulletin/2013/f13.aspx

[Errol]

It's completely impossible to foresee any of this coming. It would be totally unexpected.

[frederick]

It's completely impossible to foresee any of this coming. It would be totally unexpected.

[easy2012]

It's completely impossible to foresee any of this coming. It would be totally unexpected.

Probably certain soon to be ex BoE employee(s) are looking for some cushy jobs in the PE industry by upselling their skills in persuading the BoE/Treasury to do whatever it takes to 'prevent' the crisis.

[koala_bear]

From the BoE report p46

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2013/qb1301.pdf

Moreover, there is evidence from a recent FSA study that the practice of forbearance is particularly widespread on debt exposures associated with private equity sponsored acquisitions. This study revealed that around a third of the £35 billion of major UK banks’ leveraged loan exposures to European companies are benefiting from forbearance.(3) This would seem to indicate a high level of borrower distress. The pricing of leveraged loans is also indicative of market expectations of a high level of eventual default, with a long tail of loans held in European CLOs priced at a significant discount.

(Chart 8).

As the worst lending was done most recently, using historic default rates doesn't work , how unexpected

[koala_bear]

Probably certain soon to be ex BoE employee(s) are looking for some cushy jobs in the PE industry by upselling their skills in persuading the BoE/Treasury to do whatever it takes to 'prevent' the crisis.

This is real not "faked"

[R K]

Fred Goodwin's legacy rumbles on.............

It's increasingly clear that Merv wants to nationalise the rump of RBS, break it up and QE all this cr4p one way or another.

Probably Carney will too.

[koala_bear]

It's completely impossible to foresee any of this coming. It would be totally unexpected.

On the first Friday in July 2006 I had a big all day drinking session with some friends. One was a bank treasury counsel who outlined the numbers involved in PE and nonsensical M&A at that point and what was going to happen and how long the crash was going to take to happen.

So completely and utterly unexpected

(He was already job hunting elsewhere at that point as he had seen the way things were going...)

[OnlyMe]

We don't need this shower of shite to monitor third parties, we need a third party to monitor the bankrupt of england and stop them and their central banking mates running bubble inducing policies, bailouts and fraud against the general population.

The Bank added that it would use its new role as the watchdog of the City to monitor private equity deals in future "episodes of exuberance" to prevent a repeat of the debt-driven takeover boom in the run-up to the banking crisis.

Edited March 14, 2013 by OnlyMe

[Ash4781]

Not sure if it was this article ( capital regs ?)but it had a quote from boe chap that more capital was required but would not come from gov! Secret funds or bank collapse looming?

[easy2012]

This is real not "faked"

Yes - but with the right 'support' from the central bank such as keep rates low for a decade or two and QE until 30 years hits 0.1% then a lot of debt would be manageable.

It seemed BoE is hinting about lending via ELA to non bank

source: http://ftalphaville.ft.com/2013/03/14/1423212/bank-of-england-glasnost/

(last paragraph)

Edited March 14, 2013 by easy2012

[@contradevian]

Love the way the BoE reports this like a detached observer.

[wonderpup]

Love the way the BoE reports this like a detached observer.

It must be nice to live in world of constant unexpected surprises- life's never dull at the BoE because they never know what's coming next.

[shipbuilder]

crisis may be triggered.....systemic threat......risk to the stability of the financial system......risk to the UK financial system.......heightened fragility.......we must do what it takes..... threat to our way of life.......if you''re not with us you're against us......

[disenfranchised]

Love the way the BoE reports this like a detached observer.

But they are also apparently 'watchdog of the city', maybe they only started that job in 2008 or something? They clearly had no responsibility before at all, for anything, ever

Edited March 15, 2013 by looking for the out

[Oliver Sutton]

crisis may be triggered.....systemic threat......risk to the stability of the financial system......risk to the UK financial system.......heightened fragility.......we must do what it takes..... threat to our way of life.......if you''re not with us you're against us......

restructure....re-capitalise....contagion....deposit flight....tanks on the streets

[porca misèria]

The aspect of the article that makes sense is precisely that lending to companies was following a similar trend to mortgage lending. Both private equity and listed companies were in the same game, though it was still far from as dominant as in housing.

Bottom line, a debt bubble. Meaning money was being devalued, and growth and GDP figures wildly overstated.

[Harry Sacks]

The AA springs to mind. Massively leveraged.

[porca misèria]

The AA springs to mind. Massively leveraged.

No excuse for that. What *anker gave them money?

[Bloo Loo]

It's completely impossible to foresee any of this coming. It would be totally unexpected.

Indeed it is.

GROWTH predictions...guesses, cover up a whole economy full of rubbish. We've all seen it, we will see it in the budget..GROWTH will take care of things.

Therefore, as this is policy, reality can take a hike.

[easy2012]

The thought that these guys may not have already taken a ton of money out is laughable too. Just handing a slow burning, ticking timebomb to the banks - "here you are, it's yours"

Not really... if you look up and understand what a loan covenant is...

[tomandlu]

The AA springs to mind. Massively leveraged.

The Auto-mobile Association? What the hell were they needing to borrow for?

(edit) Four billion.... bloody hell.

http://news.sky.com/story/1045170/aa-and-saga-owner-speeds-up-4bn-debt-talks

Edited March 15, 2013 by tomandlu

[dances with sheeple]

So when this little lot blows, mortgage lending will tighten even further?

[Eddie_George]

So when this little lot blows, mortgage lending will tighten even further?

No, just more bailouts.

[Blue Peter]

Not really... if you look up and understand what a loan covenant is...

I don't suppose that you could enlighten those of us who don't?

Peter.