Private Equity Groups’ "Dry Powder" Could Be An Economic Lifesaver

Private Equity Groups’ "Dry Powder" Could Be An Economic Lifesaver
Stéphane Renevier, CFA

4 months ago2 mins

What’s going on in lending markets?

Back in the day, firms typically used two methods to raise capital. First, public debt: borrowing cash from banks or issuing bonds. Second, public equity: selling shares through IPOs. But the financial crisis changed the scene, with private entities (think venture capitalists and private debt and equity firms) emerging as formidable lending contenders to banks.

After all, banking regulations have tightened, while lightly regulated and more agile private firms have the freedom to creatively structure their deals. Investors have been checking out those private firms, lured in by the promise of heftier returns, access to exclusive deals, and their portfolios of variable-rate loans (which make them less exposed to the effects of rising interest rates). This has resulted in a flood of capital pouring into private markets funds, and there’s plenty in the reservoir: private equity firms alone are holding over $2 trillion in "dry powder" – essentially funds ready for deployment (dark blue bars). To put that into perspective, this amounts to an eye-popping 13% of total outstanding bank credit (light blue line).

Why should you care?

This considerable stash of capital in private markets is essentially cushioning companies against the impact of rising interest rates and stricter lending standards. See, even firms that may struggle to secure a bank loan or issue bonds on favorable terms can unlock financing from private markets. Alternatively, they might find themselves swept up by a private equity group. Both options give them a lifeline to reorganize their finances and potentially dodge the bankruptcy bullet. And that could explain why despite banks tightening the purse strings, credit creation hasn’t skidded to a stop: private entities are stepping in to fill the gap.

Remember, though, that these private firms aren't invincible. As I've pointed out here and here, they’re lightly regulated and the terms of their deals are not well understood – that suggests some important risks may be lurking beneath the surface. But for now, let's raise a glass to their role as financial lifesavers.



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