It is no secret that many of the UK’s largest banks have decided that in 2009 they are quite happy to own former private equity investments. These are the companies that have defaulted on their banking covenants, when the PE sponsor was either not able to or not prepared to invest further money without some reduction or conversion to equity of the existing loans. The consequence of the banks taking this stance is that much of the recycling of the ownership of businesses to new and motivated, rather than accidental, shareholders has not really begun.
It appears that in a number of cases the banks are reluctant to write down their existing loans so that they can minimise the amount of impairment across their organisations that they have to report. The motivation for doing this is understandable, taking into account other factors affecting the banks at the moment. However, this can only be a transitory phase and does not offer a real solution to the problem of businesses that find themselves over-geared for the current level of economic activity.
Of course this opinion is not universally shared. A number of banks have been recruiting individuals with private equity experience to help look after their newly acquired portfolios. Other banks have passed over their stakes in such companies to existing in-house teams with some relevant private equity experience. The challenge to the sponsor community is clear; “We can do what you guys do!”
Unfortunately, historical experience is not on the side of the banks on this issue. In the early 1990s, in similar circumstances, a number of businesses fell into bank ownership, were held there for a while and subsequently sold. The businesses that emerged had by and large been starved of all but the minimum of investment as reducing the lenders’ exposure took precedence over all other priorities. Not surprisingly the companies looked neglected and their management teams tired and disillusioned.
We are told, however, that this time it will all be different. Management teams either are or will be re-incentivised, further investment will be available etc. But then again as Mark Twain put it so succinctly “History doesn't repeat itself, but it does rhyme.”
At the time of writing, in the UK there is no sign of any sustained recovery in the levels of underlying business activity. The probability is high that this situation will continue for some time as the inevitable tax rises and cuts in government expenditure feed through the economy over the coming months and indeed years. It is therefore likely that there will be neither a swift recovery in the fortunes of many of these bank owned companies nor that their market value will increase much either. Hopefully, however, over that time the banks’ balance sheets will be under less pressure and they can then start the real recycling process.
Neil MacDougall is the managing partner of Silverfleet Capital.