Federal Reserve chairman Ben Bernanke has cautioned banks on the risks they take during the financing of private equity deals.
He added: “I urge banks to closely evaluate the risk that they’re taking, not only in the context of a highly liquid, benign financial environment, but in one that might conceivably be less liquid and benign.”
The Federal Reserve governor had been asked whether banks take on too much risk by financing private equity deals.
A bridge loan is debt provided by banks at the initial stages of a private equity deal which is later refinanced in the debt markets.
A spokesman for UK regulator the Financial Services Authority said: “We condone bridge loans, but we would expect institutions to have measures and controls in place so that they conduct appropriate due diligence on their deals.”
The FSA declined to comment on Bernanke’s speech.
In a fairly positive report on private equity, the European Central Bank also said last month that the “key risk” for banks posed by private equity was “being caught with a large exposure (for example a bridge loan) when a leverage buyout fails prior to distribution”. The International Monetary Fund also issued a far more sceptical report last month, highlighting private equity as one of the biggest threats to global economic stability.
Earlier this week, Anthony Bolton, the manager of the Fidelity Special Situations fund, expressed concern about another related worry for lenders, the proliferation of ’covenant lite’ loans in the private equity industry. Bolton said: “I think the phrase is ‘covenant lite’, but in many cases it appears to mean no covenant at all.”
Covenant lite loans are an increasingly popular means of financing buyouts in the US and to a lesser extent in Europe. The loans allow firms more independence from lenders providing them with only limited access to details of a borrowing company’s financial performance.