Last month’s FSA discussion paper on the private equity market reflected increasing industry and regulatory concern about the volume of debt in the sector. Excessive leverage is cited as a significant risk not only for the private equity houses and the companies in which they invest, but for the stability of the financial markets as a whole.
With interest rates rising and the debt and equity see-saw wavering at an unprecedented angle, it is time the private equity industry turned its attention to the other side of the balance sheet, and applied the same active management to liabilities as it does to assets, according to ECU Group.
As acquisition targets increase in size and value, and more debt is needed to finance deals, such companies are often the recipients of large unmanaged loans on their balance sheets, which reduce returns to the private equity houses and their investors.
This situation is driving private equity houses towards innovative debt management solutions. The industry is re-examining whether it’s possible to reduce debt and improve cash flow without having to liquidate assets.
One possible solution is to actively manage debt by taking out a multi-currency loan facility, which enables the borrower to switch the debt from one currency to another.
Liability reduction is achieved by placing debt in currencies which subsequently fall against sterling, thereby reducing the sterling value of the loan, and interest rate savings can also be achieved if the debt currency is lower yielding the sterling or the loan diminishes in size.
Currency trading is not without risk, and the time, expertise and market intelligence required to manage foreign exchange risk is beyond the resources of most companies.
But if successful the results can dramatically add to the de-leveraging: £100 million of debt managed by the ECU Group since 1st January 1996 would have reduced to £31,305,700 by 31st October 2006, representing a profit of more than £68.6 million in 11 years.