A series of warnings and reports have drawn fresh attention to the accumulation of risk around the private equity sector. Rebecca Jackson, the Bank of England’s executive director of authorisations, RegTech and international supervision, warned in a speech about the lack of solid stress testing among banks lending to private equity or otherwise exposed to the asset class.
Quoting the results of a UK Prudential Regulation Authority survey of bank preparedness for risks associated with lending to private equity, she cited significant gaps and wide variations in readiness, with some institutions having no capacity to aggregate or interpret data. Risks identified by the survey include creeping leverage levels, high exposures, complicated structures and poor risk aggregation.
Jackson cited multiple correlations creating risk, including support of portfolio company financing as well as buyout debt. She warned of potential severe unexpected losses, and likened the risk to the 2021-22 collapse of Archegos Capital Management, which cost Credit Suisse and Nomura some US$5.5 billion and $2.85 billion, respectively.
Triggers for such a scenario include potential malpractice at a sponsor, or bankruptcy of multiple portfolio companies.
According to McKinsey, the global private equity market reached $13.1 trillion as of June 2023. That’s an awful lot of capital at risk.
Meanwhile, Bain & Co.’s private equity outlook in March warned of a sharp decline across the board in dealmaking, exits and fundraising, due primarily to the rise in interest rates. It identified exits as the most pressing problem, with limited partners pushing for money back and withdrawing allocation to new funds.
In these circumstances, it’s not hard to conceive that some firms might come unstuck. Bankruptcy across multiple portfolio companies, for example, is more than possible in the current environment, with far higher interest rates since the original acquisition of those companies.
It’s worrying that the industry as a whole seems to be looking for more and more stopgaps and expedients to continue business as usual rather than undertake genuine structural resets. As a recent Bloomberg report highlights, an increasing number of private equity firms are attempting to borrow against their fund assets with so-called net asset value loans. Now really, what could possibly go wrong with that?
