The collapse of debt burdened firms that were bought up by private equity companies before the financial crisis could pose the next major risk to the stability of the UK's economy, the Bank of England has warned.
These leveraged buyouts (LBO), which are likely mature next year, pose a systemic threat that needs to be addressed, according to the Bank's quarterly update.
The warning from the Bank comes ahead of a major round of refinancing. Some £32bn of LBO debt has to be refinanced in 2014 and 2015, with a further £41bn of LBO debt maturing over the following three years.
"In the mid-2000s, there was a dramatic increase in acquisitions of UK companies by private equity funds. The leverage on these buyouts, especially the larger ones, was high," the Bank said.
"The resulting increase in indebtedness makes those companies more susceptible to default, exposing their lenders to potential losses.
"This risk is compounded by the need for companies to refinance a cluster of buyout debt maturing over the next few years in an environment of much tighter credit conditions," the Bank added.
As there was a surge in acquisitions in 2007, many of these deals will unwind next year, the Bank said: "The average maturity of UK 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."
The study referenced part-nationalised lender Royal Bank of Scotland, which aggressively expanded its strategy in leveraged finance amid a "search for yield" which drove up demand for leveraged loans.
The Bank said under its new regulatory framework, which is coming into effect next month, it would take on the responsibility to protect and enhance the stability of the UK's financial system in order to prevent "future episodes of exuberance" that took place at the height of the boom before the crisis.
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