Private equity drives decline in credit quality

The proportion of European corporates rated as speculative grade has more than doubled in the last decade, according to ratings agency Standard and Poor’s – thanks largely to the growth of private equity.

Private equity’s influence has brought about a long-term deterioration in the credit quality of European corporates, according to new research by Standard and Poor’s.

The percentage of sub-investment grade ratings in Europe rose to 18 percent by the end of the second quarter, up from 8 percent ten years ago, according to the ratings agency. The figures were contained in its latest report, entitled “European Ratings Distribution: Rising Variation in Ratings Mix”.

S&P suggested that the “highly favourable cost of borrowing” and “rising risk appetite among investors” were the principal reasons behind this trend, which was unlikely to reverse. This has changed the leveraged profile of most corporates – 38 percent of all first-time debt issuers are now speculative grade, it said.

The agency believes that the recent rise of private equity has been the major contributing factor to this deterioration in credit quality. Sponsors have “changed the landscape for European ratings and increased complexities”, according to managing director Diane Vazza.

The universe of companies examined in the report – over 1100 in total – only includes a small proportion of private equity backed companies. But if all of these companies were taken into account, the deterioration would almost certainly be even more marked, Vazza said.

“Through the extensive use of leverage and other equity-friendly strategies such as dividend recapitalization plans, many companies operating in the private credit market may potentially be experiencing greater downward pressure on credit quality than is visible in the rated universe.”

In general, debt levels are on the rise across Europe, S&P said. At the end of last quarter, one third of corporates had debts greater than €5 billion, up from 27 percent in 2004. More than half of European companies in the telecommunications and high-tech sectors are now rated below investment grade, with the leisure/ media sector not far behind.

However, the issue is even more evident in the US, where nine of the thirteen sectors categorised by S&P have more than half of their companies rated as speculative grade.