The New York Times DealBook blog reports a Boston Globe article interviewing private equity firms TA Associates and Thomas H. Lee Partners (thanks again to Bob Eisenbach for flagging this here). The article reinforces the view we expressed in an earlier post that lax credit standards could magnify default rates in an economic downturn.

A private equity investor borrowed at 2.25 per cent over LIBOR. When the target investment defaults, the investor can "toggle" its loan repayments into "payments in kind", borrowing more from the lender (at a 0.5 per cent interest premium) to make loan repayments. No real penalty for loan default then - hence, "covenant lite"!

This shouldn't be a problem when the odd investment defaults, but it makes a hard landing more likely than a soft one when the economy turns.

Do you think the debt bubble is encouraging private equity to store up problems, or is there enough liquidity in the system to weather any run of defaults? Let us have your comments.

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The credit that is fuelling leveraged buyouts and other private equity deals may become tomorrow's problem, according to a recent post by Bob Eisenbach. The US Bankruptcy lawyer draws on articles in the Financial Times and the Guardian (courtesy of a New York Times blog).

Sub-prime mortgage lenders are suffering in the US just now and commentators are drawing parallels to suggest that lax credit standards in the corporate arena could magnify default rates in an economic downturn. The problems will be exacerbated by investors who have chased returns and moved towards more illiquid hedge and buyout funds.

Do you agree? Are you seeing rising default rates? Send us your comments.

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