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Private Equity Could Trigger Another Crisis: Bank of England

Thursday, 14 Mar 2013 | 6:51 AM ET

The amount of leverage in the U.K. corporate sector poses a risk to the stability of the financial system and could produce the next big financial crisis over the coming years, the U.K.'s central bank has warned.

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Before the financial crisis of 2008, a dramatic increase in the amount of acquisitions made by private equity funds has made companies more susceptible to default, the bank said.

These leveraged buyouts - using a significant amount of borrowed money to meet the costs - will likely unwind in 2014 as the debts mature, according to the central bank.

"It is clear that leverage of the U.K. corporate sector has increased as a result of larger private equity acquisitions....the resulting increase in indebtedness makes those companies more susceptible to default, exposing their lenders to potential losses," the Bank of England said in a quarterly bulletin released on Thursday.

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"Such companies pose 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."

As well as the increased potential for a company to collapse, the risk to U.K. financial system from these debt levels means companies are less likely to undertake long-term investment if that investment is crowded out by the costs of servicing debt, it said.

"The average maturity of U.K. LBO (leveraged buyouts) debt is around seven years. Given that the peak in debt issuance was around 2007, there is a significant 'hump' of maturities from 2014," it said.

"As it currently stands, 32 billion pounds ($47.8 billion) of [U.K.] LBO debt is expected to mature in the period 2014–15, with a further 41 billion pounds in the period 2016–18."

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The report said that there is no clear evidence yet of a higher default rate among private equity owned companies but gave evidence that the poor performance of loans to private equity-sponsored firms since the crisis began.

At the start of 2007 nearly 14,000 firms worldwide were held in LBO (leveraged buyout ownership), according to a report by the World Economic Forum in 2008. This ownership, compared to fewer than 5,000 in 2000 and fewer than 2,000 in the mid-1990s, it said.

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To deal with leverage, the Bank of England has set up a Financial Stability Committee (FPC), with one of its roles being to monitor potential risks to financial stability and the use of debt in acquisitions in "future episodes of exuberance".

"A more complete picture on the success or failure of companies bought out at the peak of the leveraged lending boom might not become clear for many years," it said.