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ECB Vets Banks’ Private Equity Risks as Firms Face Reckoning


(Bloomberg) — The European Central Bank is reviewing how the region’s biggest banks lend to the private equity industry amid a rising threat of corporate defaults.

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The ECB is carrying out an in-depth assessment involving about a dozen large lenders to ensure they assign appropriate default probabilities to loans made to highly indebted companies, which are often owned by private equity funds, people familiar with the matter said. Separately, the ECB is collecting data from banks on the total amount of loans that they have given to companies linked with individual buyout firms, in an effort to uncover potential concentration risks, the people said.

The regulator has presented various lenders with preliminary findings on perceived deficiencies in the business known as leveraged finance, the people said, asking not to be identified discussing private information. That may result in demands from the ECB that some banks increase provisions for potential loan losses or hold more capital, they said, both of which would impact profitability.

An ECB spokesperson declined to comment.

The move by the euro area’s top banking regulator comes during a moment of reckoning for the private equity industry as interest rate hikes at central banks have put an abrupt end to an era of inexpensive credit. That has begun to push up corporate default rates, especially for companies that are already highly indebted, after a decade in which low interest rates enabled many buyout firms to acquire those companies at very high valuations.

The full effects of higher interest rates have yet to feed through in the financial system and are likely to compound challenges for borrowers, according to Kerstin af Jochnick, a member of the ECB’s Supervisory Board.

“This calls for a strengthening of banks’ risk management frameworks to keep such risks in check, especially for sectors which may be leveraged,” she said at a conference hosted by Goldman Sachs Group Inc. on Wednesday. “We think it is key for banks to manage their distressed debtors and exposures early on.”

The ECB review is the latest step in a prolonged effort to curb what the regulator sees as excessive risk taking and lax risk management by some European banks when lending to the private equity industry. As part of the clampdown, it has previously applied additional capital requirements on several lenders including Deutsche Bank AG and BNP Paribas SA in a move that has been met by frustration with some of the affected banks.

The ECB argues that banks with large portfolios of leveraged loans would likely face higher default rates than others if the economy were to tank. This means those banks should also build up sufficient reserves to protect them against such a scenario, according to the ECB.

But some of the region’s lenders including Deutsche Bank have said that tighter requirements on leveraged finance would also constrain lending to companies that have no connection to private equity firms, and so threaten to throttle growth in a vital part of the economy. They also point to low default rates in their credit portfolios as evidence that their risk management practices are up to par.

With regard to the in-depth assessment, which is known as a credit file review, the ECB has concluded work at the premises of several banks and lenders are currently providing their feedback, some of the people familiar with the matter said. In some cases, banks have pushed back against the findings, which were made with the help of external consultants working with the watchdog, these people said.

The separate survey of banks on their private equity loans, which is being carried out by questionnaire, will give the ECB a better picture of credit exposures to the industry including its sources of funding, some of the people said. One question the central bank seeks to answer is whether lenders have large credit engagements linked with just a limited number of big buyout firms, these people said.

–With assistance from Alessandra Migliaccio and Giulia Morpurgo.

(Updates with comments from ECB official starting in sixth paragraph)

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