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The Impact of the 2007 Credit Crunch on Private Equity: An Economic Analysis

This presentation by Edwin T. Burton, Prof. of Economics at the University of Virginia, delves into the implications of the 2007 credit crunch on the private equity landscape. The discussion outlines the evolution of private equity, especially the buyout business, and the significant changes in financing that emerged post-crunch. Key factors like rising defaults in the sub-prime mortgage market and the halt of structured debt are examined. Additionally, it highlights the challenges of current and future financing conditions for private equity investments and exit strategies.

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The Impact of the 2007 Credit Crunch on Private Equity: An Economic Analysis

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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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