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European leveraged loan default levels could hit 15%

Borrowers in cyclical sectors, such as the motor trade, chemicals and the media, are likely to have difficulty restructuring their debt, according to recent data. Recovery rates for European buyout debt are likely to hit their lowest ever.

Distress levels in the European leveraged loan market are due to continue rising through to 2010, according to a report from ratings agency Fitch Ratings. The firm estimates that recovery levels for European buyout debt will drop well below any historical precedents.

While there will not be a significant rise in refinancing risk across the market as a whole until 2013, Fitch estimates that default rates could rise to as high as between 10 percent and 15 percent over the next year and a half. This compares to a default rate of 2.5 percent at the end of January 2009.

It should serve as another warning to leveraged businesses and their owners.

Jonathan Trower

Businesses needing to restructure during the next two years will face several credit crunch-related obstacles, the report found, including reduced financing opportunities, few trade buyers, the possibility of contentious and delayed cross-border debt restructurings, as well as diminished medium-term sales and profit growth prospects.

Jonathan Trower, managing director in investment bank Close Brothers’ European restructuring and debt advisory group, said the view from Fitch came as no surprise.

“It should serve as another warning to leveraged businesses and their owners to be realistic about the position they may be in and to start planning early,” he said in an interview, adding that a consensual restructuring solution that helps shore up the value of a business and gives it the necessary liquidity and headroom is much more likely to succeed if talks with lenders are initiated early.

The result of tougher refinancing conditions, according to Fitch’s report, will be a possible increase in formal insolvencies leading to distressed asset sales, as was the case with Waterford Wedgwood, the luxury china and crystal maker in January. New York-based private equity firm KPS Private Equity agreed to buy certain assets of the 250-year old pottery and glassware group, which had earlier been placed in receivership.

Pablo Mazzini, a senior director in Fitch’s European leveraged finance group, said in a statement that deteriorating economic conditions had left businesses in cyclical sectors particularly exposed.

“Sectors which are closely correlated with the economy, such as building and materials, automobiles, chemicals and media-related borrowers, will likely be most vulnerable to early distressed debt restructurings,” he said.