The warning will be of concern to finance directors working in private equity and the public markets, who have relied on cheap debt and strong liquidity to make acquisitions and return cash to shareholders.

In a research study, Europe High-Yield Prospects: LBOs Create Risks For Credit Quality, analysts warned that although rating trends remained benign, the combination of more leveraged structures, dividend payouts, share repurchases and bond issues with loose covenants served as an early warning of increased credit risk once the debt cycle turned.

‘Demand for leveraged products has proliferated in recent years, led predominantly in Europe by PE sponsors,’ said Diane Vazza, head of the global fixed income research group at Standard and Poor’s.

Sponsor-led activity, which involves a range of non-traditional lenders, provides an important source of deals in the European high-yield bond market.

The advent of these players, however, has introduced uncertainty in the leveraged buy-out market’s response to enhanced volatility.

The warning from the agency followed news that UK hedge funds have slashed the level of their gearing by 10%, according to a private survey conducted by the FSA.

The FSA found that the main hedge fund lenders had cut the ratio of debt to net equity from 1.86 times in April 2006 to 1.66 in October.

Leading figures in private equity such as Jon Moulton, the head of Alchemy Partners, and Philip Yea, chief executive of 3i, have long warned about the risks of over-leveraging and the fragility of some hedge fund players.

COMPANY REPORTS

Stamp duty opens PLCs to PE takeovers

Stamp duty on public company shares makes it easier for private equity firms to launch takeovers, by suppressing share valuations, a report by Oxera claims. The report found that share values were suppressed by as much as 8.5% because of stamp duty taxation on the sale of shares. But the effect of the cost of equity for private equity firms is negligible.

Although stamp duty generates £3bn per annum for the government, abolishing the tax would increase UK GDP and possible increase the government’s tax -take by a net £1bn after the loss of £2.93bn in stamp duty receipts.

Baugur CEO guilty of false accounting

A Reykjavik court has found Jón Ásgeir Jóhannesson, the founder and CEO of investment group Baugur, guilty of false accounting after a five-year legal battle. He was acquitted on 39 other charges.

He was given a three-month suspended prison sentence after being found guilty of a charge of false accounting relating to a credit invoice for £296,771.

US lender forced to restate earnings

CIT Group has been forced to restate its first-quarter earnings ­ lowering them by 26% ­ after it decided to put off adopting an accounting rule it had previously used.

The company is at odds with the Financial Accounting Standards Board Statement No. 159 regulation, which requires companies to record financial assets and liabilities at fair value, instead of at their historical value. CIT said it had received guidance, which stated that the company could face continued earnings volatility from adopting the rule early. Most companies must adopt Statement No. 159 on 1 January 2008.