The Bank of England has issued a warning about the potential economic impact of rising interest rates on private equity-backed companies. Here are the key points from the report:
- Higher borrowing costs since late 2021 pose significant risks to private equity-backed businesses.
- Private equity-backed companies contribute around 5% of UK private sector revenues and employ over two million individuals.
- A substantial portion of maturing debt in risky credit markets over the next five years originates from private equity-backed companies.
- The Bank of England highlighted the potential adverse effects on the banking system and broader economy due to potential debt defaults.
In its latest financial stability report, the Bank of England has underscored the substantial risks arising from the increased borrowing costs that have been observed since late 2021. Private equity-backed businesses, which account for approximately 5% of the UK’s private sector revenues and employ over two million individuals, are particularly vulnerable due to their heavy reliance on leverage.
The central bank’s biannual report cautioned that companies may curb investments or reduce employment levels as their private equity financiers are required to refinance their debts at higher interest rates. “The widespread use of leverage within private equity firms and their portfolio companies makes them particularly exposed to tighter financing conditions,” the Bank stated.
Recent transactions, such as the acquisition of Morrisons by Clayton, Dubilier & Rice for £7 billion and the potential £5.4 billion deal involving Hargreaves Lansdown and CVC Capital Partners, exemplify the significant activity in the private equity sector. However, the report indicated that 25% of all debt maturing in risky credit markets over the next five years is linked to these private equity-backed companies.
The Bank of England has urged private equity firms to enhance transparency regarding the size and quality of their assets. Its investigation into the sector concluded that potential losses on loans could adversely affect the UK banking system, which has seen increased lending to private equity firms. This, in turn, could elevate borrowing costs for businesses if private equity-backed companies fail to meet their debt obligations, ultimately harming the real economy.
Higher borrowing costs, which have ascended from a historic low of 0.1% to 5.25%, represent a 16-year high. During periods of low borrowing costs, the private equity industry expanded substantially, growing from $2 trillion in assets in 2013 to $8 trillion today. The Bank warned that such scenarios could “reduce investor confidence,” thereby exacerbating financial pressures on businesses.
Michael Moore, CEO of the British Private Equity and Venture Capital Association, acknowledged the concerns raised by the Bank of England. He pointed out that the industry’s long-term stability and resilience are underpinned by recent regulatory activities from the Financial Conduct Authority, which address many of the issues highlighted by the Bank.
Meanwhile, the Labour Party has pledged to eliminate a tax rule allowing private equity executives to minimise their tax liabilities if elected in the upcoming general election. Presently, private equity executives benefit from “carried interest” being taxed at the capital gains tax rate of 28%, rather than the combined income tax and national insurance rate of 47%. The proposed changes aim to tax carried interest at the higher rate, potentially addressing a tax break valued at approximately £4 billion.
The Bank of England’s warnings underline the significant economic implications of rising interest rates on private equity-backed firms, urging transparency and regulatory interventions to mitigate risks.
