Fitch warns of the consequences of aggressive restructuring

Fitch Ratings, has published a report encouraging investors to be wary of increasingly aggressive financing structures in European leveraged buyout transactions. The paper outlines the necessity for the market to try and avoid potential credit blow-ups. The agency notes that the current high levels of liquidity in all leveraged asset classes, combined with an improving macroeconomic environment and increasing bidding competition for assets, could result in overly aggressive capital structures and unsustainable debt levels for new leveraged buyout transactions.

In a report entitled ‘It's a Rollover – but not a Lottery’, Fitch reviews the performance and issuance activity within the leveraged credit markets in 2003 and notes the buyout market's growing reliance on the recycling of existing transactions, either by secondary/tertiary buyouts or via straightforward recapitalisations. The report also comments on the substantial growth in the non-LBO leveraged corporate lending sector, reflecting a series of large restructuring transactions for fallen angels such as Ahold, Vivendi Universal, Alstom and HeidelbergCement.

Fitch notes that the trend towards increasing financial leverage in LBO structures, exemplified by the hike in average total leverage ratios to 4.8x in 2003 from 4.4x in 2002, reflects renewed confidence among investors and the market's strong appetite for deals. Although a number of the recent, more highly leveraged transactions relate to seasoned credits with a proven ability to operate with financial leverage or to issuers in sectors with traditionally stable cash flow profiles, the risk exists that less robust transactions will find their way to market.

Key observations and statistics within the report include the following: 1) The overall leveraged loan market witnessed new issuance of EUR 109.3bn in 2003, up 25% from the EUR 87.4bn seen in 2002, largely thanks to impressive growth in the leveraged corporate segment, where issuance grew by 51% to EUR 74.7bn against the 2002 total; 2) Despite the relative dearth of jumbo deals in 2003, the LBO sub-sector held up well, with new issuance growing slightly to EUR 34.6bn from 109 deals, compared with the EUR 33.6bn from 104 deals seen in 2002. 3) LBO issuance was dominated by general manufacturing (21 deals), leisure & entertainment (10) and retail & supermarkets (10), but the presence of 22 industry sectors across the spread of 109 new deals reflects the growing diversity of the market.

Looking ahead, the agency notes the LBO pipeline appears to be very healthy, with a number of sizeable buyouts agreed towards the end of 2003 set to come to the senior loan and high yield markets in the next few months. With the cable sector also set to make a comeback and continuing good prospects for new issuance in the corporate leverage space, potentially boosted by increasing M&A activity, the whole sub-investment grade debt issuing arena seems set to benefit from improving macro-economic conditions, strong market liquidity and restored confidence.

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