Private Equity Crash Could Trigger a Financial Crisis: BOE

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A large number of British companies would soon pose a risk of default due to the highly leveraged acquisitions made by private equity funds before the financial crisis of 2008, warned the Bank of England Thursday. These debt-laden companies are more susceptible to default. The central bank said that entire U.K financial system could witness massive instability if the debts aren’t restructured or refinanced.

Private Equity Crash Could Trigger a Financial Crisis: BOE

The bank has established a Financial Stability Committee (FPC) that will monitor the use of debts in private equity buyouts future “episodes of exuberance.” The watchdog will also monitor the potential threat to financial stability to avoid the repeat of the past debt-driven acquisition boom.

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In the first six years of the last decade, there was an unbelievable increase in the number of buyouts by private equity funds. Most of these acquisitions were financed with debts that became a liability of the purchased firm. The central bank has evidence that commercial banks were too lenient when lending money to private equity funds.

The size of such deals continued to increase, and this trend was further helped by easing of credit conditions by banks as they tried to attract more business. Bank of England cited the example of Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) which is now 83 percent owned by the government after the Treasury bailed out the bank in October 2008. Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) had aggressively expanded into leveraged finance.

The British leveraged buyout debts mature in about seven years. Since most of the debt issuance took place before 2007, there would a large pile of debt maturing from 2014. The Bank of England expects that about 32 billion pounds ($47.8 billion) of leveraged buyout debts are expected to mature in 2014-15, and another 41 billion pounds of debts to mature in 2016-18. A big trouble is that the companies will have to refinance debts at a time when credit conditions have become much tougher.

Private equity funds argue that leveraged buyouts make them more efficient by pushing the company management to make regular investment payments. But, in reality, it prevented companies from making long-term investments.

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