The leveraged buyout (LBO) default cycle is ticking up even without the big push from the former TXU, though many private equity-backed companies will continue to win reprieves thanks to yield-hungry investors willing to help refinance debt for the time being.
The Energy Future Holdings (EFH) bankruptcy in April pushed both the junk bond and leveraged loan default rates to their highest points in several years. The trailing 12-month U.S. high yield default rate was moved to 2.8 percent and the U.S. leveraged loan railing 12-month default rated was pushed up to 3.9 percent. While this was a dramatic increase in the default rate, the market didn't register much of a shock, because the former TXU had been expected to file for Chapter 11 protection for years.
But according to Fitch Ratings, LBO-backed companies are defaulting at twice the rate this year as they were last year, not including the Energy Future filing. As of May 28, 10 private equity-owned companies not including EFH defaulted on debt so far this year, compared with 11 for all of 2013.
LBO company defaults have affected $6.5 billion in bonds and loans. The EFH default totals $35.8 billion in affected debt and accounts for 29 percent of the defaulted debt from 2007 to today.
Other LBO-backed companies that have defaulted so far in 2014 include Guitar Center, which defaulted on about $535 million in debt on April 3; Sorenson Communications, which sought Chapter 11 protection in early March with $735 million in affected debt; Travelport, which launched a distressed exchange to add $135 million in debt to the roster; and Brookstone Co., which defaulted on $125.6 million in debt in February.
Some of these companies received refinancing reprieves in years past, which may have pushed them to default at later times. The Fitch report cites chemical company Momentive Performance Materials, which filed for bankruptcy on April 13. The company, which defaulted on more than $2.8 billion in debt, notes that the 2006 vintage buyout managed to refinance its loans into bonds between 2010 and 2012.
That scenario continues to be possible today. "The insatiable demand for yield product in a persistently low interest rate environment continues to drive investors into speculative grade loans and bonds," the report notes. LBO defaults that originated in deals from the boom years of 2004 to 2007 have affected $55.3 billion in bonds and $64.5 billion in loans. Of the combined $120 billion of this debt, 63 percent of that comes from bonds and loans priced between 2004 and 2007 and the remainder is comprised mostly of LBO debt that was refinanced between 2008 and 2014.
While LBO-backed companies may have increased the clip at which they are defaulting, they have not registered significantly different recovery rates so far. The average 30-day post-default recovery price on LBO bonds between 2007 and this year was 47 percent of par versus a non-LBO average rate of 45 percent of par. Among institutional first-lien leveraged loans, the 30-day post-default price was 61 percent of par for LBO loans versus 63 percent of par for non-LBO loans. In Fitch's group of 95 companies with price data at its emergence from bankruptcy, recovery outcomes on first-lien LBO and non-LBO loans were comparable at 74 percent of par.
Year-to-date defaults total 15 issuers with $22.4 billion on bonds versus 13 issues with $5.9 billion in the first fourth months of last year. So far this year, 95 percent of defaults have come through Chapter 11 filings versus about 54 percent last year. This is largely skewed by the former TXU.