Even though global loan defaults have quadrupled in 2008, the percentage of defaults with private equity fingerprints on them has decreased in the past quarter, according to a new Standard & Poor’s report.
Titled “Private Equity Swirling In The Eye Of The Storm,” the report states that 53 of the 86 loan defaulters this year have been involved with private equity firms, which equals 61%. Compare that with the ratings agency’s September report, which traced 70% of the 55 defaults back to private equity firms.
I’m not sure what the drop means, other than an increase in companies with non-LBO leverage are having a tough time servicing their debt. In general, I predict a spike in defaults in 2009 but don’t expect the percentage of private equity involvement to change much. It seems that PE-backed companies led the bankruptcy wave in the first half of the year, and corporates have been catching up ever since. The tsunami of PE-backed Chapter 11s peHUB called for in the Q1 of next year will likely be matched by a hurricane of corporate filings.
The S&P report gives private equity a pass altogether, actually, saying, “The stability offered by sponsors’ financial strength may have deferred or even averted some defaults.” Does the capital position of a sponsor really affect a portfolio company? Sponsors are usually split on the idea of “throwing good money after bad,” or, infusing capital into failing companies, so an LBO shop rich with LP commitments does not necessarily mean it’ll step in to save portfolio companies from default.
But in so many words, the report blames the slowing economy, frozen lending markets, and “deteriorating assets” for the high percentage of PE-backed defaults. It completely ignores the high leverage multiples that came with exorbitant purchase price multiples and excessive dividend recaps of the recent wave of buyouts. And like S&P’s last report, the author seems to believe all PE firms target troubled companies at cheap valuations with the goal of turning them around. I’ve said it before, but anyone who thinks every PE firm is that noble, skilled and prudent must have been asleep for all of 2006 and early ‘07. Only a small percentage of PE firms self-identify as turnaround artists. The author adds that the turnaround model works well when liquidity is ample. Unless it’s in reference to exits, this also makes no sense-any turnaround sponsor worth his weight in fund commitments knows you don’t buy ailing companies with leverage.
But nitpicking aside, more defaults are coming, the report states. Both corporate and sponsor-backed companies will bring us to the 7.6% default rate S&P is predicting for a year from now. The ratings agency also predicts (vaguely) that private equity exposure to defaulting companies will “remain elevated.”
Download the report, with a full list of the 86 defaulters and their backers here: S&P Report 11.19