Inefficient debt pricing helping PE sponsors

Ratings agency Standard & Poor’s (S&P) continues to wring its hands over the loan market, with its latest worry concerning the lax way in which loans are priced in Europe, which is encouraging private equity firms to maximise leverage.

Paul Watters, director of loan and recovery ratings at S&P, said at a recent conference: “We have a situation where sponsors are usually prepared to accept as much debt as the banks are prepared to underwrite. If the senior debt syndication goes well then the spread margins might be reduced, or ‘reverse flexed’, by 25 basis points at most. The leveraged loan market does not materially reward sponsors for bringing a well-structured credit to the market or, conversely, penalize them for presenting an overly aggressive or poorly structured transaction.”

This is in contrast the US debt market which is much more stringent. The agency argues Europe lacks a systematic approach for distinctions in price based on the quality of the credit and the security provided.

S&P also followed-up its argument from last year that private equity firms, rather than improving the equity value of their portfolio businesses, are instead preferring to recapitalise its investment. As a result, and according to S&P’s leverage loan index, at the end of January this year, 72% of loans were rated B+ and B, a 19% increase from the end of 2004. S&P argues this is very high. In the US the figure is 41%.