A wave of leveraged-buyout debt is beginning to crash down on Europe's shores

Over the next five years, some $550 billion of loans made to European companies taken over in leveraged buyouts will mature, according to data crunched by Dealogic for U.K. law firm Linklaters LLP, in a study to be published Tuesday.

A wave of leveraged-buyout debt is beginning to crash down on Europe's shores, Dana Cimilluca reports on Markets Hub. Photo: Reuters.

The scale of the maturing debt is daunting in itself, but a number of additional factors—including weak economies in Europe and tightening capital requirements for banks—could make it particularly acute for lenders and borrowers, according to the report, titled "Negotiating Europe's LBO debt mountain."

In a worst-case scenario, default rates, already rising sharply, could surge further, resulting in additional pain for both banks and private-equity firms, whose returns have been hampered by economic head winds and the absence of robust markets for deals and initial public offerings that they rely on for selling their investments.

Unlike in the U.S., where many big private-equity-backed companies are gaining breathing room by refinancing through a booming junk-bond market, banks in Europe are in little mood to grant these firms fresh loans. The region's junk-bond market, meanwhile, is less developed than that of the U.S., although European companies could seek to borrow in the U.S.

Even if companies are able to refinance their maturing debt, they may have to pay a higher interest rate for the funds, adding another burden and reducing the returns for private-equity companies.

Should companies be unable to refinance or pay off their debts, creditors could be forced to accept less than what they are owed, sometimes in the form of equity.

To be sure, markets could become more hospitable. Europe's high-yield-debt market could return to the rapid growth of the two years to mid-2011, if worries about the euro zone's more financially troubled governments continue to ease. Other providers of capital, such as insurance companies, pension funds and hedge funds, could buy new debt, though in some cases these players may be looking to pick up existing loans at a discount to their face value in anticipation of a restructuring.

The debt mountain facing private-equity firms goes back to 2004, when the last buyout boom began. Cheap credit helped fuel a historic wave of LBO activity on both sides of the Atlantic, as private-equity firms bought companies using a mix of their own cash and—predominantly—borrowed funds. The boom lasted for nearly five years, until the 2008 financial crisis. In Europe, most of the money came from bank loans.

The debt begins to come due in earnest this year; $69 billion of European LBO loans will mature, according to the Linklaters report.

Already, some companies are struggling to cope with the debt they took on. In one high-profile deal, Terra Firma Capital Partners spent $6.7 billion, much of it as debt, to buy EMI Group Ltd. in 2007. EMI's lender, Citigroup, foreclosed on the record company early last year.

A number of factors are conspiring against banks' willingness to pony up more funds in the form of risky leveraged loans. For one, many of the firms are heavily exposed to sluggish domestic markets; the euro-zone economy is expected to contract slightly this year and grow only modestly thereafter. New regulations are forcing banks to hold more capital and to reduce leverage, which is likely to reduce their appetite for such loans. Moreover, the ability of so-called Collateralized Loan Obligation funds—traditional buyers of LBO debt—to buy new debt is limited, as many of these funds will soon mature and return money to investors, taking them out of the market.

"The economic and banking environment has changed considerably" since the buyout loans in question were made, Chris Howard, a Linklaters partner in London who co-authored the report, said Monday. "It's a major problem."

All this could drive up an already high default rate for leveraged-loan-backed companies. The default rate for the Standard & Poor's European Leveraged Loan Index was 4.1% in December, more than double the year-earlier level, according to the report.


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