Debts imposed by private equity funds on companies like Freescale and NXP could cause the next big financial crisis, with $500 billion of such debt needing to be rescheduled by 2010, according to the Bank of International Settlements.
Large numbers of companies which have had huge debts loaded on them by private equity owners, may be in breach of their banking covenants in the next month or so.
"Covenants are in danger of being breached because operating profit will be insufficient to cover interest payments", says Jon Moulton, boss of the private equity firm Alchemy Partners, "firms will go bankrupt or will need to be rescued by the banks via debt-for-equity swaps."
According to the Observer there are between 50 and 200 private equity-owned companies which are in danger of default before the New Year. In the first half of this year, half of all debt defaults were by private equity-owned companies.
NXP has to pay between $450 million and $500 million in debt service every year and Freescale has to pay $700 million, as a result of debt loaded onto them by their private equity owners KKR and Blackstone respectively.
Moreover, starting in 2011, they have to start re-paying the capital of the debt as well as the interest.
According to Jerome Ramel, of French bank BNP Paribas "There is no way they can repay the debt they have", said Ramel, "even if NXP and Freescale are broken up there is no way they can repay the debt which they have."
The only way out of making the capital debt repayments is to try and re-finance the debts. Ramel commented: "Refinancing will kill some businesses."
Because of the implications for job losses and business failures, the Unite union is calling on the government to force the private equity industry and the banks to disclose their liabilities.
The disclosures should reveal:
How much leveraged buyout debt is on their books?
When the principal and interest payments are due?
Who owns the debt?
Is it owned by any banks or financial service companies who are receiving government bailout money?
Whether the company is in danger of defaulting on repayments or declaring bankruptcy?
What cost cutting steps are being considered to free up cash flow to make their debt payments?
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