The US sub-prime mortgage market crisis and its subsequent repercussions across the globe will have a significant impact on equity-backed firms, according to the credit insurer Atradius. However, it could be a necessary correction to the market to rebalance the level of debt taken on by corporates.
The share of private equity transactions with a debt to operating profit multiple higher than six increased to over 36% until mid 2007. In 2002, this share only accounted for 4%, reflecting the increase in debt capital in relation to operating results in certain private equity deals. “Certain private equity backed companies are now more highly indebted than ever before. We believe that this credit market slump marks the end of an era of ‘equity anorexia’, the irrational financial leveraging of companies. Also, we are approaching private equity deals presently in the pipeline with vigilance,” explains Anno Kamphuis, chief risk officer of Atradius.
“We believe a pricing adjustment in corporate debt is required to re-establish a sound basis for the future. It makes it less attractive to load companies with unhealthy levels of debt. Certainly, in an economic environment where operational cash generation becomes more uncertain and the price of corporate debt goes up, it will make companies and its shareholders think twice about the risk they take in increasing corporate debt to the hilt,” he adds.
However, despite the immediate impact of this market correction, Kamphuis assesses that based on the reasonable growth of major European economies, companies should be able to generate enough operational cash flows to mitigate any potential risks of not being able to pay debt and trade payable obligations.