DEFAULTS on leveraged buyout deals were rising strongly and might be "significantly higher" than ratings companies' estimates as about $US500 billion ($520 billion) of debt used to fund the takeovers falls due, the Bank for International Settlements said.

Companies bought by private equity firms worldwide must repay the high-risk, high-yield loans and bonds by 2010, the Switzerland-based bank said in a report on Thursday, citing Fitch Ratings data. They might find it hard to raise the funds because of a slump in demand for collateralised debt obligations that pooled the loans, BIS said.

Investors were shunning structured debt instruments such as CDOs - the main buyers of leveraged loans - after the credit market freeze caused by the US subprime mortgage collapse, BIS said.

The ability of LBO firms to refinance may be crimped further as banks tighten lending criteria after reporting $US402 billion of credit losses and asset writedowns.

"The risk of a significant increase in LBO firm defaults in the next few years may have risen substantially," BIS said. "With prospects for a recovery in demand from securitisation vehicles in 2008 remaining uncertain and banks having little capacity to fund new loans, refinancing risk remains a key challenge for many LBO firms."

Defaults may be "significantly higher" than forecast by ratings companies because of the leverage that buyout firms use to acquire companies, BIS said, citing year-end default-rate predictions of 4 per cent.

The default rate on high-yield notes worldwide rose to 2 per cent in May, from 1.7 per cent the previous month, and was likely to reach 6.3 per cent by May next year, Moody's Investors Service said.

Buyout firms borrow to finance about two-thirds of the cost of acquisitions. The debt they raise is rated below Baa3 by Moody's Investors Service and BBB- at Standard & Poor's.

Investors are demanding more in interest relative to benchmark rates to buy high-yield debt. The average US leveraged loan yielded 413.2 basis points more than the benchmark London interbank offered rate this year, compared with 270 basis points at the end of last year, S&P said.

Sales of collateralised loan obligations, or CLOs, slowed to $US30 billion in the first quarter, less than half the amount a year earlier, BIS said, citing JPMorgan Chase data.

The total of outstanding CLOs expanded to almost $US250 billion last year, more than double the amount in 2004, according to the report, prepared by the bank's committee on the global financial system.

CLOs repackage loans into new securities with varying credit ratings and returns. The range of participants means it may take longer for holders of debt to get their money back after a default because of potential "friction" between different creditors during restructuring, the BIS report said.

"Agreements between creditors were often relatively easy to achieve when creditors were solely banks, but may be less straightforward when non-bank creditors are involved," the report said.

Bloomberg