Private equity has become the focus of a plethora of news articles, mostly concerning its current travails. The latest is a Bloomberg report headlined “The Private Equity Bubble Is About to Deflate”. According to the report, “the industry is due for a reckoning, and the consequences for the economy are dire”.
The analysis echoes a recent Financial Times report that says “private equity managers have tended to write down their assets’ value by far less than the falls in public markets”, an overvaluation caused by “the tailwind of freakishly loose monetary policy” - cheap leverage instead of the value enhancement that private equity claimed to deliver.
Private markets by their nature don’t provide clear and open market-derived asset valuations. With multiples down, funding costs up, and weaker balance sheets, the FT report argues that “writedowns should be far greater than for public equity”. The recent decision by the US Fifth Circuit Court of Appeals to throw out the Securities and Exchange Commission’s new transparency regulations has reinforced the problem.
Another private equity-related legal decision has raised further problems given the likely wave of bankruptcies and restructurings among privately-held assets. As reported in the FT, law firm Vinson & Elkins was denied a second attempt to be retained as bankruptcy counsel for Enviva, a wood chip manufacturer indebted to the tune of almost $2 billion, by Judge Brian F. Kenney of the Eastern District of Virginia. The issue? The law firm is also representing Riverstone Investment Group, Enviva’s 43% equity holder, a clear conflict of interest, according to Kenney. This judgement risks upsetting long-established close ties between law firms and their private equity clients.
Nonetheless, there are at least some signs that private equity firms are actually adjusting their practices to accommodate the new reality, rather than simply insist on business as usual. According to the FT, private equity firms have pulled back heavily on the use of so-called net asset value loans, secured against the total value of their funds.
With the usual exit options looking increasingly difficult, private equity firms have been using these loans to pay dividends to their institutional investor limited partners. However, after concerns over the added risk commensurate with these loans, their use for dividend payments fell by about 90% in value in the second half of last year, according to figures from specialist lender 17Capital quoted by the FT.
The total value of the NAV loans still looks worryingly high, with 17Capital quoting $16.4 billion in 2023, some four times the 2020 figure. But any move by private equity firms to readjust to market realities is likely a good sign, especially when it indicates responsiveness to their investors.