The standards of leveraged loans used to fund private equity buy-outs have loosened in Europe this year in spite of the credit crisis, sharply raising the risk of corporate defaults, Standard & Poor’s warned on Wednesday.

Record levels of leverage in deals, rising purchase price multiples and the falling ratio of cash that companies have available to cover debt will make it harder for them to repay their loans and put pressure on default rates, the ratings agency said.

“Just because investors are demanding more conservative structures does not mean they are getting them,” it said.

The ratings agency said this was surprising, given that defaults are expected to rise sharply this year.

Taron Wade, S&P research analyst, said: “The less cash flow or the more debt companies have, the higher the risk of default. In the current market, where the availability of debt has declined and business prospects are deteriorating, you would expect deals would get more conservative.

“However, a lot of the transactions have been done in local regions, where bank investors may have strong relationships and are comfortable with the credits.”

The report said investors might have been comfortable with highly leveraged deals because many of the companies operate in strong sectors .

The cash that companies have available to cover what they have borrowed fell in the first quarter to 2.2 times their debt levels, compared with 2.5 last year and 4 in 2003, S&P said.

Among smaller deals between €250m (£197m) and €500m, the amount of leverage used to buy a company rose sharply in the first quarter to 6.8 times debt to earnings before interest, tax, depreciation and amortisation from 5.8 times in 2007. However, larger deals of more than €500m saw the amount of leverage used to fund buy-outs fall.

Average purchase price multiples for leveraged buy-outs continued to increase in the first quarter, reaching 10.4 times ebitda compared with 9.7 times in 2007. Buy-out bosses said the S&P figures suggested private equity firms had reacted to the credit crisis by becoming choosier about which deals they tried to finance. But industry executives said the trend might have been skewed by the small number of deals in the first quarter.