OREANDA-NEWS. The current state of the mergers and acquisition (M&A) market poses some risks for U.S. companies, despite the shift away from leveraged buyout-driven (LBO) transactions, according to Fitch Ratings.

Strategic M&A is a mixed bag in terms of risks and rating implications. The breakneck pace of strategic M&A activity continues to increase the risk that U.S. companies will overleverage balance sheets and/or miscalculate synergy prospects. Consolidation has led to stronger competitive positions in some cases (including operating synergies) while in others it has been a driver of top line growth for industries facing secular challenges and difficulty in growing revenues organically.

Total M&A volume in the loan market came very close to setting a record high in 2014 ($457 billion versus $471 billion in 2007) and is on pace to post similar numbers in 2015. However, the composition of this M&A cycle is significantly different from the previous peak in 2007. Fitch believes the decline in the share of leveraged loan M&A issuance is primarily attributed to the drop in LBO volumes. LBO loan issuance of $95 billion in 2014 is less than one-half of the $207 billion in LBO volume recorded in 2007. September 2015 year-to-date LBO issuance of $57 billion is only a fraction of the volume seen in the previous cycle peak.

Sector consolidations and strategic acquisitions have dominated the recent M&A scene. Companies have been able to successfully execute M&A transactions by using large cash positions, investment-grade financing, and their own equity. Generally rich valuations can make LBO returns unfavorable with the more limited leverage levels associated with the current regulatory environment. However, strategic buyers can justify paying the higher multiples needed to execute M&A transactions with their potentially greater ability to shed significant costs and/or realize revenue opportunities.

Leveraged lending guidance has limited the amount of debt financial sponsors can use to execute transactions. Among the more explicit guidelines, regulators have noted leverage levels above 6.0x as one cause for concern. High valuations and these restrictions on highly leveraged deals have created more limited opportunities for financial sponsors to complete deals. Regulators appear to have made an impact in this regard as the average leverage on LBO deals completed through September 2015 is down to 6.1x from 7.1x in 2007.