The management of leveraged buyout credits by bank credit functions in Europe : risk factors and their use
Abstract
LBO transactions were structured increasingly aggressive in the years prior to the
outbreak of the financial crisis (2007), as reflected in rising debt proportions. This was
followed by many LBO credits experiencing difficulties to adhere to their loan
documentations. Bank credit functions played a role in this, giving rise to an
investigation into whether their work could be more effective. To identify areas for
improvement in their work of evaluating LBO credits and – if such areas can be
identified – deduce some potential measures how to address them was the aim of this
research. The research is timely as evaluations of LBO credits continue to be required
heavily. Many of the credits structured around 2006/2007 will soon require refinancing
and in parallel new transactions come to the market.
A literature review on the risk factors and cycles relating to LBOs, the simple
techniques of portfolio management and LBO credit management practices found that
all the ingredients required for effective LBO credit management are available. This is
in conflict with the observation of increasing credit risk inherent in these transactions in
the years just prior to the outbreak of the financial crisis of 2007. Based on this, 18
experts were interviewed. The results were analysed quantitatively and qualitatively. To
enhance robustness, results were discussed with four senior credit executives as well as
a focus group discussion of the credit function of one bank.
The exploratory results of this research suggest that there is strong awareness of the risk
factors in LBOs. The systematic risk in LBOs in form of an LBO cycle however is not
considered to a significant degree in credit analysis/credit monitoring. Some important
risk factors also receive relatively little attention in credit analysis/credit monitoring and
aspects of portfolio management are not used strongly at the level of credit functions.
Finally, an area of improvement that had been identified was the utilization of results;
i.e. the need to draw consequences from observations made with view to risk factors.
Due to the limited scope of the study, updating the results with more recent data as well
validation and triangulation of results remain recommended.