Fitch Ratings: Credit Quality Deteriorates Among U.S. Loan-Financed LBOs.

NEW YORK -- A Fitch Ratings study has found that overall credit quality is eroding and default risk rising among U.S. companies that were taken private through a leveraged buyout (LBO) over the last four years. Rating Outlooks also point to further downward pressure on these credits in the months ahead.

In its study, Fitch reviewed 209 loan-financed LBO transactions executed between 2004 and 2007, accounting for approximately $293 billion in leveraged loan debt.

'The greater risk tolerance that existed in years past enabled many of these deals to come to market with very aggressive capital structures,' said William May, Senior Director, Fitch Ratings Credit Market Research. 'Now that economic conditions are weak and liquidity is tight, these credits are being tested.'

The analysis found that from the completion of an LBO through May 2008, the ratio of downgrades to upgrades among these firms was 3.3-to-1.0 and the average downgrade was 2.3 notches. Weak operating performance and an inability to generate sufficient cash flows to service post-LBO debt loads were the primary drivers behind approximately 80% of the downgrades. Additional post-LBO debt issuance used to fund a dividend payment to the equity sponsors of the LBO was the second most common driver, accounting for 15% of the downgrades.

While seasoning certainly plays a role in the distribution of downgrades through time, one indication of the toll current economic and credit market conditions are taking on these credits is that over one fourth of the downgrade actions and three of the four recorded defaults occurred during the first five months of 2008.

Looking ahead, it appears that these credits will come under increased pressure as approximately 44% of the LBOs examined had a Negative Rating Outlook as of May versus just 3% with a Positive Outlook.

The review also found that 23% of LBO credits examined consisted of firms in consumer cyclical industries and a further 15% were in the broad industrial category, evidence that a meaningful share of the LBOs brought to market in recent years are particularly sensitive to the type of macroeconomic weakness and consumer retrenchment the U.S. economy is currently experiencing. The recent bankruptcy of Linens 'n Things is an example of this vulnerability.

While the study finds that Negative Outlooks exceed Positive Outlooks in all of the major sectors examined, consumer cyclicals and industrials lead the way in pointing to downward pressure on credit quality going forward.

The full report titled 'Credit Quality Weakens for Loan-Financed LBOs' is available on the Fitch Ratings' website www.fitchratings.com.

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