Loan investors warned over default risks

Leveraged loan investors are playing a dangerous game by ignoring recovery prospects says Standard & Poor’s European Leveraged Finance group in its new newsletter, “Leverage Matters.” The ratings agency argues too many investors assume that debt structures are all basically the same, and so risk overlooking the differences that do exist in the event of a default.

“Leverage is crucial in these transactions,” says Standard & Poor’s credit analyst and managing editor Audrey Whitfill. “No two capital instruments have the same risk characteristics, which means recovery of principal in the event of default should merit greater attention from market participants. Recovery prospects will significantly affect returns as the credit cycle turns down.”

With the European leverage market continuing to show no signs of slowing down, more than 20 LBO deals came to the market in the nine months till the end of September requiring more than €1bn of debt, S&P is concerned the influx of new investors to the debt market could mean the more inexperienced among them could be unaware of the potential risks involved.

“Debt has so far borne the brunt of this downward credit trend in the leveraged market, but, worryingly, about 80% of the volume of leveraged loans are publicly unrated, compared with 70% in 2004,” she said. “And with volumes increasingly coming in at lower rating levels, it seems that the market still is not taking credit risk fully into account when pricing loans.”