With leveraged buyout firms emerging as some of the most active users of bank loans, one rating agency is examining the effect these firms have on the ability of the companies they sponsor to repay their debt.
Fitch Investors Service is developing a data base to track financial sponsors, their buyout funds, and their deals. A report outlining some of the New York rating agency's initial findings is due out Thursday.
The report comes as the LBO industry is more active than ever. Through September $26.695 billion of buyout funds had been launched this year, up from $15.295 billion in all of last year, according to Buyouts, a newsletter published by American Banker.
Meanwhile $28.964 billion worth of such deals were completed in the nine months, compared with $13.908 billion in all of 1996.
As sponsors become significant issuers in the syndicated loan market-and some of the most coveted corporate clients of banks-"certain rating consideration must be paid to what expertise a sponsor brings to a deal," said Randy Szuch, director of Fitch's loan products group, and co-author of the report.
In the report, Fitch outlines some of the qualitative aspects of an LBO firm's relationship with the companies it sponsors that affect a company's ability to repay its debt. These include:
The sponsor's record of providing economic and operational assistance after an initial investment.
The sponsor's investment horizon.
The sponsor's track record in the industry.
The appropriateness of the sponsor's equity contribution to certain transactions.
"Our approach is to look at the historical track record of the sponsor" to get "a glimpse as to how they are likely to perform going forward, not just from a financial standpoint, but also from a qualitative standpoint," said Jim Roche, co-author of the report.
Fitch wants to determine whether sponsors "have the qualitative and operational infrastructure and the intention to support a transaction financially or otherwise," added Mr. Roche, an associate director of Fitch's loan products group.
Often, successful sponsors have concentrated on leveraged buildups, Mr. Roche said. They have narrowed their focus to specific industries in order to gain operational expertise.
"It's very important that someone's been through that," Mr. Roche said.
Bank loan syndicators and investors welcomed the new attention that LBO transactions were drawing from the rating agency.
"It's always helpful to have other people looking at one of these things on an independent basis," said one investor. "It raises awareness."
LBO firms are prospering in the robust financial market, the report's authors acknowlegde, but their value will emerge when there is a market turn, they say. The firms will then have to "use whatever financial expertise they have to rejigger a deal to keep it afloat," Mr. Szuch said.
"Fundamentally there's a lot of liquidity in the market which is supporting these deals," he explained, but "it's hard to say, absent the liquidity, if the deals stand on their own merit."