Bank of England warns lenders to buyouts

In a report likely to catch the attention of the UK Parliament’s Treasury Select Committee investigating private equity, the Bank of England has highlighted the increased risk of systemic failure if a large buyout defaults.

The Bank of England has stoked the debate about leveraged buyouts ahead of the second evidence session for the industry in front of the UK parliament this week by warning of a global economic downturn, sparked by a single large defaulting buyout.

In its Quarterly Review today, the bank said: “The failure of a large leveraged loan that left intermediaries with unexpectedly large commitments could prompt a widespread disruption.”

“In the event of a significant disturbance, there is great uncertainty surrounding how the shock would be transmitted through the financial system,” it added.

It also criticised banks for their increasingly easy lending in buyouts deals. It alleged the ready availability of cheap credit might leave some borrowers unable to cope with the amount of debt on their books in a downturn.

In particular the bank singled out so-called ‘covenant-lite’ deals.

It said: “Market contacts suggest that covenant weakening partly reflects intense competition among lenders, which has led to general loosening in credit standards.

“Lower levels of risk compensation may reflect an overly optimistic assessment of the likely level of asset market volatility going forward, a view accentuated by continuing high levels of liquidity in financial markets.”