In early July regulators, bankers and private equity GPs rubbed elbows at the Federal Reserve Bank of Chicago's eighth annual conference on private equity, organized by the Fed's Private Equity Merchant Banking Knowledge Center.
The conference was entitled “Navigating the New World of Private Equity.” The attendees' outlook was less rosy than in years past, according to the center's lead examiner, Bill Mark.
“The buyout market seems to resemble what it was in the early to mid-90s,” he notes. “Deal structures are tighter and the cost of financing is higher. Private equity professionals are naturally optimistic, that's the nature of their business, but they're certainly less optimistic about what's going on right now.”
Mark has led the center since its inception in 2001. The center was formed to address the need to build and maintain a comprehensive supervisory infrastructure after the passage of the Gramm-Leach-Bliley Act in 1999. The act gave banking organizations and financial holding companies more freedom to pursue merchant banking activities, an industry the Fed was less familiar with. In order to better monitor this line of business, the Fed created the center as a repository for expertise and quantitative information.
At this year's conference, both the regulators and the regulated had plenty of questions. Mark noted that the backlog of buyout-related debt was the most prominent concern voiced by all.
“One of the biggest concerns that came up, that permeated through out the audience was the credit market,” he says. “There were several speakers that spoke about what's happening in the credit market and how there is still a backlog of leveraged loans at lender banks that's not readily saleable. It's going to be very hard to get financing for private equity deals until that backlog is reduced. What we gathered from the conference is that [PE firms] are looking at just as many if not more deal than they have in the past. They're making fewer deals, because they have to put more of their own money out there.”
“Most private equity professionals don't like the thought of more regulation, but I got the sense that there could be a middle ground.”
Another topic that piqued Mark's interest was a discussion of the risk of conflicts of interest. Now that both banks and private equity firms have multiple lines of business, and have the ability to be owner, lender and advisor to a portfolio company, that risk is a significant one.
“In addition to equity investments, banking organizations want to lend to the portfolio companies and provide other services such as investment banking and asset management,” Mark says. “Invariably every relationship involves different legal entities. With each relationship comes specific obligations and sometimes these obligations conflict. The challenge to these organizations is to manage these conflicts and ensure that all the interests are aligned.”
In the aftermath of the credit market crisis in the US and abroad, banks and private equity firms alike are facing the specter of increased regulation. But that was one topic not addressed at the conference.
“I think [some of the speakers] may have wanted to stay away from that topic in front of an audience mostly made up of regulators,” Mark says. “And truth be told from our perspective, most of what's being talked about now is still up for consideration and review. It was not possible or appropriate for us to take a position. Consequently, we focused on other salient topics.”
But he noted that although everyone was treading lightly around the issue of regulation, he got the impression that the GPs in attendance weren't entirely hostile to the idea.
“Most private equity professionals don't like the thought of more regulation, but I got the sense that there could be a middle ground,” he says.