September 21, 2017 / 12:42 PM / a year ago

Fitch: EMEA LevFin Risks Tempered by Debt Affordability, Reforms

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: European Leveraged Credit Risk Tempered by Lessons from 2005-2007 here LONDON, September 21 (Fitch) The European leveraged credit market's inherent vulnerability to shocks from valuation and leverage multiples at pre-crisis highs is mitigated by ample debt service headroom, private equity financial sponsors' changing approach to asset selection and post-crisis regulatory reform, Fitch Ratings says. We therefore see significant differences between the re-leveraging characteristics of the current market and that of 2005-2007, although higher senior leverage levels and aggressive terms and structures on small and mid-market credits introduce new risks. Post-crisis reforms in the global banking system under Basel III are a key difference. Banks have been recapitalised and their balance sheets re-weighted with high-quality liquid assets such as sovereign debt and central bank reserves. Structured credit vehicles that invest in leveraged credit products are also more conservatively structured and their long-term liabilities are funded by a more robust and diverse set of global investors. Upcoming ECB guidelines should also limit the rise in total debt-to-EBITDA ratios, as happened in the US from 2014. The cost of borrowing has fallen despite the rise in leverage, helped by the ECB's asset purchase programmes and issuers' preference for cheaper senior debt. This has translated into easier interest payment burdens and longer maturity horizons. This greater debt-service headroom means the vast majority of our leveraged finance portfolio could comfortably cope with even an immediate 200bp rise in borrowing costs. Private equity financial sponsors have turned since the crisis towards growth-oriented niche sectors such as financial technology, medical technology and diagnostic or laboratory services instead of competing on price for established businesses in mature sectors. These asset-light and more service-oriented sectors generally have high operating and free cash flow margins and are less vulnerable to volatile working-capital funding requirements. They have consistently performed to their budget expectations and delivered de-leveraging, although higher debt multiples and extended deleveraging profiles upon refinancing have prevented upward credit migration. It also appears financial sponsors are taking longer-term views on investments and their business plans incorporate less aggressive assumptions on revenue and EBITDA margin expansion than before the crisis. However, new risk factors have accompanied the current re-leveraging cycle, although they will take longer to materialise. Higher senior leverage on weaker documentation translates into lower expected recoveries in the event of default. Moreover, aggressive valuations and credit terms increasingly apply to mid-market sponsor buyouts, which may amplify execution risk for businesses with less diversified product and end-markets. For more information on the similarities and differences between the current market and the pre-crisis period, see "European Leveraged Credit Risk Tempered by Lessons from 2005-2007" available at or by clicking the link above. Contact: Edward Eyerman Managing Director Leveraged Finance +44 20 3530 1359 Fitch Ratings Limited 30 North Colonnade London E14 5GN Paul-Antoine Conti Senior Director Leveraged Finance +44 20 3530 1292 Simon Kennedy Senior Analyst Fitch Wire +44 20 3530 1387 Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: The above article originally appeared as a post on the Fitch Wire credit market commentary page. 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