“There are good times just around the corner,” the government chants, in the vain hope that constant repetition of the refrain will make it a reality. So how inconsiderate it was of the Bank of England to suggest that there could soon be a sizeable financial crash rather than an economic boom preparing to hit the country?
The BoE’s warning at the end of last month was stark: UK banks have taken on huge exposure to opaque structures without keeping tabs on the risks involved.
If this sounds like a pretty basic failing in banking practice, it is because that is what it is. Hence the chief executive of the Financial Conduct Authority, which is supposed to regulate the UK’s banks, was quick to take issue with the alarm call.
But the FCA could not deny the fact that banks have channelled shedloads of money into the private equity sector in recent years as the public company market has shrunk. The Bank of England argues that there should be routine stress testing of that exposure but “hardly any banks do it well”.
The phrasing may be cautious but, to anyone acquainted with Bank of England-speak, it is equivalent to a flashing red light with extra screeching sirens. If the scale of the 2008 financial crash appeared to take the Bank somewhat by surprise, it is not going to risk missing the next one.
Were the private equity sector to implode, the impact would reverberate far beyond the finance houses. Its amorphous structure makes it difficult to put a figure on the scale of the sector but data specialist Prequin had a go last year and estimated it was $8tn globally.
Even though falling valuations would have reduced that, it is still the case that private equity owns a vast number of businesses. In the UK, major supermarkets and social care providers are just the most obvious private equity-owned businesses.
Some have already run into financial difficulties already but the scenario for a tightening squeeze has heightened concerns. Private equity funds borrow on a heroic scale and aim to squeeze more cash out of the assets they buy so as to fund the debt with which they have loaded the business. The low interest rate environment of recent years was the dream scenario for the PE players but they are not so happy now, with borrowing costs so much higher.
As at old-fashioned children’s parties, pass the parcel has been a favourite game in the sector. When a PE owner was ready to part with a business and pocket a profit – for many, a couple of years could count as a long-term hold – a sale to another PE firm was often the easiest option.
This could make some sense if it entailed marrying together companies in the same sector, so offering the opportunity for potential efficiencies, but sometimes even that rationale seemed missing.
Today’s harsher interest rate environment has shrunk the appetite for acquisitions. Equally, the alternative route to realising a profit, a stock market flotation, is now a rarity as investors have started to shun the London market.
Tough times, then, for the people behind the private equity boom but sympathy is unlikely to be overwhelming. One former chief executive of a leading publicly quoted high-street business explained to me why he had chosen to move to the discreetly elegant Mayfair offices from which he now operates. “The clue,” he said, “is in the name: it is private and I get equity.”
The privacy is undeniable: few people are aware of the fact that Morrisons and Asda are now spared the scrutiny given to the financial performance of rivals Sainsbury and Tesco because they are PE owned. But the type of equity that private equity provides is very special, thanks to its privileged tax treatment. The lucky partners share a slice of the profits generated when a business is sold but the gain is viewed as capital rather than income and taxed accordingly.
This generous regime has contributed hugely to the wealth of PE partners, some of whom have shown their gratitude by donating to the Conservatives. Chancellor-in-waiting, Rachel Reeves, has pledged to do away with this irrational bonus for a sector which is increasingly seen as having done more for its partners than for the companies that have been through their hands.
That hit, however, would be small compared with the toll that a real private equity collapse could have on the banks that have provided so much leverage for the funds.
Perhaps even greater damage, though, would be sustained by those who rely on services which, arguably, should never have been in the hands of private equity. Children’s homes, care homes and the like should surely not be subject to the extreme profit pressures that drive this sector – and yet they have been a magnet for it.
There have already been egregious examples of the risks this generates. Hesley Homes was entrusted with the care of some of the most vulnerable children but dreadful cases of abuse emerged between 2018 and 2021.
At the time, Hesley was owned by Antin Infrastructure Partners, which declared that its aim was “seeing potential, delivering value”. The inmates of the homes might have had potential but should probably not have been viewed as a profit source.
The same is true of care homes, where private equity is now responsible for much of the provision that used to be down to local authorities and small family businesses. A few years ago, the collapse of Southern Cross and then Four Seasons demonstrated the devastating effects that a private equity squeeze could have on individuals.
If the Bank of England is right, the reverberations of the banks’ lax lending to the sector will reverberate around the country.
