Debt recoveries of PE-backed companies comparable to non-sponsored businesses

The average rate of debt recovery for private-equity-backed companies is comparable to that of companies with no PE presence, a study shows.

The conclusion by the debt research firm Moody’s Investors Service, based on a study of 226 sponsored deals from 1987 through 2016, pushes back against the notion that PE-backed companies’ balance sheets are more fragile, at least when it comes to paying back lenders in the event of a debt restructuring or bankruptcy.

But the type of debt is also a factor. The study showed that recovery rates are lower for PE-backed companies with subordinated bank debt or unsecured bonds.

“Investors should not forget that increased leverage typical of LBOs with a sponsor, and debt-financed dividends, may put companies at a greater risk of default, especially when credit conditions deteriorate,” the study said.

The Moody’s study, “Private Equity Tactics Keep Firm-Wide Recoveries Close to Average,” showed that an average of 56 percent of debt is recovered with private-equity-backed companies, compared with 55 percent for non-sponsored companies.

Distressed exchanges and prepackaged bankruptcies provide the key to higher recoveries, Moody’s noted. Both these transactions are widely used by PE firms. Overall, distressed exchanges produced the highest average recovery of any type of default, at 75 percent for private-equity-sponsored deals and 71 percent recovery with no private-equity backing.

“The high proportion of distressed exchanges and prepackaged bankruptcies among defaulted companies with a private equity sponsor resulted in a relative parity of firm-wide recoveries of non-PE defaulters,” Julia Chursin, associate analyst at Moody’s, said in a statement. “Large PE firms tend to favor distressed exchanges as a restructuring tool.”

Various subordinated bank debt facilities of PE-backed defaulters fared much worse, with a 36 percent recovery rate, lower than counterpart recoveries of 53 percent.

“In those instances when subordinated tranches of bank debt did recover relatively higher (about 52 percent), they were structured as mezzanine debt with a debt cushion below it,” Chursin said. “When there was no cushion, subordinated bank debt recovered only 22 percent, similar to unsecured or subordinated bonds.”

So far this year, oil-and-gas companies comprised the highest share of PE defaulters out of 14 economic sectors. Eleven oil and gas companies defaulted in 2016, compared to four in 2015. The second-weakest sector in terms of defaults is retail, with six in 2016, up from only one in 2015.

Action Item: Contact Moody’s: www.moodys.com/Pages/contactus.aspx

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