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The booming private equity industry poses a threat to global financial stability by exposing banks to credit risks and by leaving debt-saddled target companies vulnerable to economic shocks, the International Monetary Fund says.
In its latest six-monthly Global Financial Stability Report, the IMF says the current wave of leveraged buyouts differs from those during the 1980s and late 1990s in that both the size of the deals and the level of debt involvedhad increased.
However, the IMF said unlike previous LBO activity, the current wave was largely being funded through loans that were sold through a process of syndication to highly professional investors rather than through high-yield, or "junk", bonds.
While that resulted in less concentration of risk, banks faced particular issues during the syndication process, which could take several months.
"During this time, adverse market events could render the deal unattractive. The bank that has provided bridge finance or has underwritten the provision of the leveraged loans would be at risk during that period and could suffer large losses as a result of adverse market developments.
"A collapse in one or more high-profile deals could leave banks with exposure during the syndications stage and could trigger a wider reappraisal of risks across a broader range of credit products."
The IMF also said higher debt levels potentially increased the vulnerability of acquired firms to economic shocks.
"This is reflected in the downgrade in credit ratings of several targeted companies," the fund said.
The private equity industry raised $US430 billion ($592 billion) last year and is forecast to raise $US500 billion ($688 billion) this year, as significant investors, including Asian central banks, institutions and wealth managers, and Middle Eastern countries flush with petrodollars.
Given the amount of money continuing to pour into the sector, competition for viable deals would intensify.
"Already, ratings agencies have warned that the number of viable targets has diminished.
"The strong demand for all elements of the capital structure of these deals means that prices are often bid up to levels that represent high multiples of earnings."
The IMF said current takeover activity was taking place against a benign backdrop of continued global growth, low real interest rates, high corporate profitability and low volatility.
If one of those factors changed, it said, it was likely that some private equity deals would fail to live up to expectations.
Mergers & Acquisitions Industry
* Last year global merger and acquisition activity totalled a record US$3.6 trillion with the size of the average deal rising from about $US400 million during the late 1990s to about US$1.3 billion.
* Deals are getting bigger as few companies are too large to be considered potential targets.
* The IMF says the current wave of M&A activity is driven by a number of factors including target companies' strong balance sheets, their less-than-optimal capital structures, and a wish to avoid regulatory costs associated with being publicly listed.
* The sheer weight of private equity money looking for a home is also driving deals.
