The role of large global banks in the leveraged buyout market is becoming riskier due to the ongoing liquidity crunch, but these risks should be manageable, says Fitch Ratings in a new report.

The financial institutions most active in the LBO market are usually the world’s largest and most diversified firms including Citibank Inc., Goldman Sachs Group Inc., Bank of America and JP Morgan Chase and Co. in the U.S. and Barclays Bank PLC, Credit Suisse, Deutsche Bank, HSBC, Royal Bank of Scotland and UBS in Europe. Among Canadian banks, TD Bank Financial Group and RBC Financial Group both show up in Fitch’s analysis, which focuses on the 20 largest LBO transactions that were pending as of July 31 and the 10 largest LBOs completed so far during the year.

“Banks are now in the position of having to take on risk in a LBO market where previously they’ve been able to benefit from very liquid markets that allowed large volumes of deals to be processed while the bank focused on serving the role of advisor, intermediary and temporary warehouser of risk,” said James Moss, managing director and head of North American Financial Institutions for Fitch Ratings.

“The abrupt change in available liquidity in the market, or put another way, the quick reduction in investor appetite for LBO loan risk has resulted in the bank’s balance sheet becoming a longer-term home for LBO loans, which exposes the banks earnings to fluctuations in price of these assets that were so hotly desired by so many just a short-time ago,” Moss continued.

Fitch’s analysis of the banks’ role in the current LBO market emphasizes that it believes banks have the flexibility to ride out a prolonged period of illiquidity, but the agency does worry that such a scenario is unlikely to stay contained strictly to LBO loans.

Although, even under extreme scenarios, Fitch believes bank capital ratios stand up very well to a highly illiquid LBO market. And, it says, the banks’ large and diversified earnings profiles should allow them to emerge relatively unscathed, even if they had to fund deals at par and subsequently sell at distressed prices.

“Fitch expects the current situation to produce some near-term pain with no long-term or systemic risk issues for the large bank universe,” Moss said. “While conditions can change and the pain could be deeper and more prolonged, likely it’s survivable.”