Tightening Credit Conditions

Location: Chicago
Author: Eric Tutterow
Date: Wednesday, September 5, 2007
 

The U.S. leveraged finance markets will likely remain under pressure in the near term with a massive forward calendar overhang of approximately $350 billion, resulting primarily from the announcement of numerous large leveraged buyouts (LBOs), according to a report from Fitch Ratings.

There is a high likelihood that many of the transactions on the Fitch Forward Leveraged Loan and High Yield calendars will be restructured to some degree in order to clear the market. Changes will likely include higher risk premiums, increased equity contributions by sponsors, and stronger covenant packages.

'The debt market environment for the remainder of 2007 will be more conservative with higher borrowing costs and tighter lending standards for issuers,' said Eric Tutterow, Managing Director, Fitch U.S. Leveraged Finance.

Fitch believes a key question now is how severely lead arranging institutions may pull back their capital given their mortgage difficulties and the increasing number of hung loans on their balance sheets. This could well stem the flood of recent LBO transactions.

Fitch notes that the current illiquid credit environment in the leveraged finance markets is occurring against a landscape of positive economic growth, fairly strong corporate earnings and low high yield default rates. The U.S. high yield default rate moved modestly upward during 2Q07 for the first time since February 2006. However, the trailing 12-month default rate remained subdued at 0.6 percent.

Primary high yield bond issuance reached a record at $51.6 billion during 2Q07, surpassing the previous record of $51.1 billion set during the 4Q06. Second quarter issuance was up 35 percent from 1Q07 issuance of $38.2 billion.

Leveraged loan issuance surged to a record $215.9 billion in the second quarter of 2007, up 28 percent over the same period in 2006. Volume for the first half of 2007 reached a record $427 billion, nearly 70 percent of 2006's full-year record volume of $612 billion due to strong LBO and merger and acquisition (M&A) activity.

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