Greater Transparency Needed in European Leveraged Finance
The liquidity crunch and subsequent collapse in investors’ confidence expose significant structural weaknesses in the European leveraged finance market, according to Standard & Poor’s.
“Specifically, borrower friendly structures, coupled with a dearth of public credit ratings, obscure the credit quality of leveraged transactions and adversely affect pricing. With default risk rising on the back of an economic slowdown in the U.S. and Europe, greater transparency is vital,” S&P says in a new report, A Call For Greater Transparency In The European Leveraged Finance Market.
S& P says its recent move to extend postdefault recovery analysis to unsecured loan and bond issues sold by speculative-grade corporate issuers should help.
Nevertheless, we believe the transparency issues need to be fully addressed if the region’s leveraged finance market is to grow in the current economic environment.
European investors are increasingly focusing on the true credit risk within their portfolio, but primary market prices have not followed suit, S&P says. Although there has been a very sharp repricing of risk in the secondary market in recent months, there has been only a limited change in primary pricing in the leveraged loan market.
“It could be assumed that European primary margins are lower than those in the U.S. because of an increase in credit quality across new issues, but the credit quality of new issues is in fact falling across Europe: In 2007, we assigned public ratings of ‘B-’ to 10% of issuers, representing a dramatic change in risk profile across the leveraged loan market compared with five years ago.”
In the U.S., meanwhile, there has been a significant flight to quality, with prices moving very quickly and abruptly to reflect the change in demand–akin to the volatility seen in 1991. Risk-versus-reward prospects therefore seem much better for U.S. investors, further emphasizing the need for change in Europe, S&P says.
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