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2007 “Credit Crunch” – Implications for Private Equity

2007 “Credit Crunch” – Implications for Private Equity. Edwin T Burton Professor of Economics The University of Virginia Trustee, Virginia Retirement System. The Wynn Las Vegas, Nevada October 1 st , 2007. Private Equity before the Credit Crunch of 2007.

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2007 “Credit Crunch” – Implications for Private Equity

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  1. 2007 “Credit Crunch” – Implications for Private Equity Edwin T Burton Professor of Economics The University of Virginia Trustee, Virginia Retirement System The Wynn Las Vegas, Nevada October 1st, 2007

  2. Private Equity before the Credit Crunch of 2007 • The modern version began in the early 1980s • Mostly a “buy-out” business of private and small public companies • Financed mostly by principal lenders (mainly the larger commercial banks) • Huge growth in the 1990s • Various forms of the “buyout business” • Some very large public buyouts • Middle market buyout business • Beginnings of the “corporate governance” PE funds towards the end of the 90s. • Speed bump in returns in the 2000-2002 Period • Returns outstanding in the 2003-2007 Period • Change in financing • Leveraged loan financing • Structured financing

  3. The “Credit Crunch” in Brief • Began with the concern in Feb, 2007 of rising defaults in the sub-prime mortgage market (defaults 14 percent by late spring) • Spread to the structured debt market in late June, early July • Then a cascading effect because of “conduits” and hedge funds • Practically all “structured debt” stopped in the 2nd week of July • ABCP fell apart forcing tapping of bank lending lines • Hedge fund cascade • Structured debt positions became “unmarkable” – thus higher collateral • Force selling in long/short equity funds – partly due to the rise in volatility • The collapse of the yen carry trade • Leveraged loan problems in the broker-dealer community due to buyout financing commitments • Why – 2 things • Leverage • Lack of transparency in the “structured debt” market

  4. Implications for the buy-out business • Financing will have more contingencies (meaning “outs”) for the lender to escape • Could slow down the number of deals • Make them less certain, e.g. Blackstone’s purchase of EOP • The lending will be more restrictive to the borrower • “Structured debt” will not be available to solve balance sheet restructuring issues • Exit strategies will be far more difficult

  5. Current Situation • Lots of equity money on the sidelines • But debt financing will still be required to make the numbers work • Exist strategies will be more difficult • Some are not effected: • Venture funds, e. g. • Some will gain: • Distressed debt funds, e.g. • But, for most, the future is challenging (lower returns in the future, after recent experience, will not be welcome)

  6. END

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