BIS warns about explosion in debt for takeovers


By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, June 12, 2007

The Bank for International Settlements has warned that the current takeover boom across the world is being funded by ever greater levels of debt, storing up trouble should rising inflation lead to a sharp rise in interest rates.

The bank's quarterly report, released today, said merger and acquisition activity had reached an unprecedented $1,100 billion (£560 billion) in the US over the first five months of this year, and $1,000 billion in Europe.

Just 12 percent of the deals in the first quarter were financed by equities, compared with an average of 50 percent during the last technology merger boom of 1998 to 2000.

"Instead, companies have been taking on more debt to finance deals: total signings of syndicated loans for leveraged buyouts surged to $82.3 billion in the first quarter of 2007, almost double the amount in the previous quarter," it said.

The elite bank of central bankers, known for severe admonishments from its Swiss lair in Basle, is clearly disturbed by the promiscuous use of debt. In an earlier report, it warned that extreme leveraged buyout deals were likely to lead to a "sharp increase in corporate defaults" once the global credit cycle began to turn.

The spigot of easy money has been kept open by the proliferation of new financial instruments. The BIS said issuance of collateralised debt obligations (CDOs), packages of mortgages or other asset-backed forms of debt sold as securities, reached a record $251 billion in the first quarter alone.

Appetite for risk is showing up in huge transfers to Eastern Europe. The BIS said interest rate spreads on emerging market bonds had fallen below those of corporate bonds in the same risk category.

The flow of private credit to the developing world reached $341 billion in 2006, up from $232 billion in 2005; 60 percent went to the ex-Communist states, with explosive growth in Romania, Bulgaria, Ukraine, and the Baltics -- much of it in euros or Swiss francs.

Cross-border banks claims jumped $1,000 billion in the last quarter of 2006 alone to reach $13,000 billion, a sign that the excess liquidity sloshing around the world has not even begun to drain away.

Outstanding positions on the derivatives markets are $415,000 billion, roughly seven times world GDP -- and up 12 percent over the last six months. They grew 24 percent in the preceding six months.

The compound effect is a two-fifths rise in global derivates in one year.

The BIS cautioned that these are "notional" sums. "Gross market values, which measures the cost of replacing all existing contracts at a given point in time, remained roughly stable at $10,000 billion at the end of December 2006," it said.

Offshore banks, chiefly in the Cayman Islands and other parts of the Caribbean, increased credit volumes 23 percent last year to $3,300 billion.

Meanwhile, the US role is steadily declining. Just 15 percent of the estimated $1,000 billion of accumulated bank holdings of OPEC oil exporters remains in America. Some 71 percent is now in European accounts, and most of that is passing through London.

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