The Bank of England has issued its most severe caution yet regarding the risk to financial stability emanating from the $8 trillion private equity market. Amidst rising interest rates, both buyout firms and their affiliated companies are facing challenges.
Reflecting increasing concerns, the financial policy committee announced in its quarterly update that it is conducting a thorough examination of the potential risks embedded within the private equity sector, which expanded rapidly during the era of ultra-low rates following the 2007-2009 financial crisis.
The committee also warned that financial markets, in general, are overly optimistic about the potential magnitude of future interest rate reductions by central banks. This optimism heightens the possibility of a significant market downturn if policymakers fail to meet investor expectations.
Buyout firms traditionally rely on debt to fund business acquisitions, a strategy now strained by increasing borrowing expenses. Bank officials advised that these risks must be meticulously handled, particularly given the opaque nature of asset valuations and overall leverage levels in private markets, which pose challenges for regulators in evaluating potential threats.
Banks lending to the industry and private equity-owned companies are under scrutiny, particularly those seeking to alleviate pressure from rising rates through refinancing deals like "amend and extend" transactions. Such refinancing efforts may exacerbate corporate debt burdens, especially for companies already considered risky borrowers due to the leverage stemming from their buyouts.
