Banks give preferential rates on loans in takeover craze

Banks Are Lending to Private Sector
at Less Than Prevailing Interest Rate

By Edmund Conway
The Telegraph, London
Friday, June 1, 2007

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/06/01/cnbank...

UK banks are taking the unprecedented step of lending to the private equity and hedge fund sector at below the official UK interest rate.

Experts said it was a sign of City institutions' growing desperation to buy into the booming alternative investments market.

For the first time since comparable records began, the loans from banks to non-bank financial institutions are being charged at below the base rate, according to figures published by the Bank of England.

They are the latest evidence of the frenzy surrounding the sector, and may help explain how private equity groups have managed to fund ever more ambitious takeovers of major companies. High street chain Alliance Boots recently became the first FTSE 100 company to be taken over by a private equity group, after US giant KKR paid £11.1 billion.

Experts also warned that it underlined the extremely low level of risk priced into these investments -- despite repeated warnings about the potential pitfalls facing some deals.

The Bank said the rate at which banks lent to financial institutions outside the banking sector -- which is dominated by private equity and hedge funds -- dropped to 5.24 percent in April, below the then base rate of 5.25 percent. The rate is even further below LIBOR -- the London Interbank overnight rate, which measures how much money in the wider markets costs -- of 5.58 percent.

The phenomenon is known to be of concern to the Bank of England, which fears that the wide availability of cheap money could contribute to higher inflation. It has said that the statistics may also reflect the fact that big banks are lending money to their subsidiaries at preferential rates.

David Owen, chief European economist at Dresdner Kleinwort, said that although the recent run of statistics ran back only to 1999, he suspected that the situation of banks lending, on average, beneath the base rate was unprecedented.

"It's absolutely bizarre," he said. "I've covered the UK for a long time and I've never seen anything like it.

"Banks are simply falling over themselves to lend to these people. This phenomenon really began when the recent mergers and acquisitions cycle started in 2003.

"It's symptomatic of the amount of liquidity in the system. It helps explain why the financial system has remained so active, and why London property prices have remained so high."

An industry insider said: "This is probably a function of how highly competitive is the market to provide funding to private equity groups.

"It's that competition which is pushing down the margin -- though most groups are still paying a substantial margin of premium to the base rate."

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