Warning signs fail to dampen high-leverage loan market

Jon Moulton, head of Alchemy Partners, and Sir Ronald Cohen, co-founder of
Apax Partners, are just two of the high profile figures who have sounded dire
warnings about the fragility of highly-leveraged businesses.

Moulton and Cohen both predicted that debt markets and companies carrying
high levels of debt were in danger of collapse because lenders were taking too
many risks and offering capital too freely.

The high-leverage loan market, however, has shown no signs of slowing down.
In fact recent research suggests that rather than slow down, the market is
actually going to increase even further in 2007.

In 2006, over the three months to November, the average leveraged buy-out in
Europe reached the record level of 9.4 times earnings. According to credit
rating agency Standard & Poor’s these levels will be surpassed in 2007 as
private equity funds alone have raised almost €90bn (£60.7bn) to fund deals.

A survey of 200 banks, hedge funds, corporates and private equity houses by
Deloitte reached similar conclusions, and found that almost all respondents were
expecting leverage levels to increase or stay the same this year.

Almost 90% of the banks surveyed believed this would be the case, with 80% of
corporates and 83% of hedge funds holding similar views.

‘This reflects an anticipated increase in corporate leverage on the back of M
&A activity and returns of capital to shareholders.

The debt market continues to take a sanguine view of higher leverage levels
and seems to be pricing for increased risk,’ James Douglas, debt advisory
partner at Deloitte said.

Somewhat ominously, however, only 40% of the private equity firms polled
believed leverage levels would climb, reflecting a more sober view of where debt
markets are headed.

Separate research from Standard & Poor’s took a similarly cautious view,
forecasting weakening credit quality in the UK as a result of the high levels of

Blaise Ganguin, Standard & Poor’s chief credit officer for Europe, said M
&A, share-buybacks and dividends were all placing pressure on company
balance sheets. He said this was encouraging riskier, more speculative lending

‘Issuers continue to maximise leverage and choose structures which heighten
their vulnerability to financial or business setbacks,’ Ganguin said.

Ganguin added that the number of institutional investors involved in
leveraged transactions had also escalated. This would complicate the resolution
of future company defaults.

Related reading