June 4 (Bloomberg) -- The risk of default on debt used in leveraged buyouts is rising in Europe as companies struggle to repay record amounts borrowed, according to Standard & Poor's.

The ratio of cash companies have available to cover their obligations dwindled on buyouts carried out in the first quarter this year to 2.2 times debt from 2.5 last year and 4 in 2003, S&P analysts wrote in a note published today.

``What should be a real concern for investors is the fall in cash-coverage ratios, which are lower than in 2007, when they were already at record-thin levels,'' Taron Wade and David Gillmor wrote.

S&P's warning adds to predictions from Moody's Investors Service of a surge in European defaults on high-risk, high-yield debt to 3.9 percent by year-end from 0.7 percent in February. Defaults on junk bonds worldwide rose to 1.29 percent in April, the highest in a year, from 1.14 percent in March, S&P said last month.

S&P cut its ratings of nine high-yield borrowers in Europe in the second quarter, up from four in the same period last year.

In leveraged buyouts, firms put up some of their own money and borrow the rest, piling debt onto the company being acquired. The equity contribution this year has risen to 42 percent from 34 percent in 2007, S&P said. Debt taken on in the buyout is classed as high-risk, high-yield and is rated below investment grade, or less than BBB- by S&P and Baa3 by Moody's.

LBO Downgrades

Kloeckner Pentaplast GmbH, a German maker of plastic wrappers owned by Blackstone Group LP, was cut to B- from B in March by S&P, which cited ``sustained pressure on KP's earnings and cash flows.'' Blackstone bought the company from London- based buyout firm Cinven and JPMorgan Partners LLC in May last year.

S&P also cut ATU Auto-Teile-Unger, which is 80 percent owned by Kohlberg Kravis Roberts & Co., to B- from B in February on concern of a potential breach of loan conditions by the company in Weiden in der Oberpfalz, Germany. ATU was granted a waiver on its loan covenants after KKR and Doughty Hanson & Co., which also owns a stake, proposed putting in 140 million euros ($216 million) of cash.

Leverage Rising

Buyout firms announced $119 billion of acquisitions worldwide this year, about a quarter of the $403 billion in the same period of 2007, as the upheaval in credit markets made lenders reluctant to finance the deals, data compiled by Bloomberg show. No high-yield bonds have been sold in Europe since July as investor appetite for riskier assets waned.

While the bond market is closed to new LBOs, banks have provided financing, according to the report.

Coor Service Management Group AB, the Stockholm-based building-services company acquired by Cinven Ltd. in London last year, borrowed the equivalent of 6.7 times its annual earnings before interest, tax, depreciation and amortization, or Ebitda, S&P said. GET A/S, the Norwegian cable operator, got leverage of 6.5 times.

``Both of these examples demonstrate the ample liquidity available from local bank lenders to fund private-equity transactions,'' the analysts wrote. ``Leverage has not fallen as much as would be expected in a market plagued by lack of liquidity.''

Deteriorating Quality

The credit quality of new borrowers declined, with 93 percent of European high-yield debt issued in the first quarter rated in the B category, between four and six steps below investment grade, up from 78 percent last year.

Some of the smaller LBO deals pose the biggest risks, according to S&P. Companies took on debt at a record 6.95 times Ebitda on average for buyouts of less than 500 million euros, S&P said. That compares with 5.8 times in 2007.

Leverage in acquisitions of more than 500 million euros declined to less than 5.5 times Ebitda in the first quarter, down from more than 6.3 times in 2007.

The ``thin credit metrics'' means companies have less of a cash cushion to absorb losses or to invest in their business, resulting in a greater risk of default, the analysts wrote. The default rate in Europe was 1.3 percent in 2007.

The report is titled ``Lending Standards in Europe Continue to Loosen Despite a Small Reduction in Leverage.''

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net

Last Updated: June 4, 2008 08:29 EDT