Editor’s letter – April 2008

The fear factor

It was in his inaugural speech on March 4 1933 that the new President of the United States, Franklin D Roosevelt, delivered the famous words: “The only thing we have to fear is fear itself”. More than one recent press article has reminded us of these words, which seem to have a strong resonance today. To some it may seem overly dramatic to imagine standing on the verge of a new Great Depression. But in light of US economist Martin Feldstein’s view that the US is facing its most serious recession since the Second World War, perhaps it can’t be dismissed as entirely fanciful.

Certainly, fear seems to have been the dynamic behind a number of recent jitters in the banking sector. When the rumour spread that the UK’s biggest mortgage lender, Halifax Bank of Scotland, was about to reveal £130 billion (€166 billion; $259 billion) of new losses, the ensuing panic resulted in the bank losing 20 percent of its market value within half an hour of trading commencing on the London Stock Exchange. It transpired the rumour had been made up by short sellers hoping to profit from others’ fears. They succeeded.

made up by short sellers hoping to profit from others’ fears. They succeeded. In the private equity market, the damage has so far been relatively contained. To an extent, this appears to have much to do with the way deals have been structured over the last year or two so as to give lenders much less control over what happens when things go wrong. A recent Financial Times article identified so-called “zombie companies” within private equity portfolios, i.e. firms bought in heavily leveraged deals just before the credit crunch and which are now judged by investors to be worth less than they owe to creditors. They have “unsustainable financial structures but no triggers for the banks to force them to renegotiate” according to Edward Eyerman, head of European leveraged finance at ratings agency Fitch.

These, perhaps, are problems for another day. In terms of visible blows already delivered to the asset class, the recent £60 million worth of write-downs at fund of funds SVG Capital caught the eye – though SVG insisted these were more than offset by improvements elsewhere in the portfolio and that it was well placed to weather the storm. The Carlyle Group will no doubt say it can also successfully ride out the collapse of its mortgage-backed securities fund, Carlyle Capital – even if, in retrospect, it may wish its brand had not been associated with the type of vehicle that arguably reflected the ‘irrational exuberance’ of the day.

In this climate of fear of what lies around the corner, our Fundraising Special (starting on page 63) explores whether investors continue to be as committed to private equity in more challenging times as they were during the boom years. On the whole, the answer appears to be ‘yes’ – but not a ‘yes’ that’s free from reservations.

Enjoy the issue,

Andy Thomsonandy.t@peimedia.com