LBOs Face Their Day of Reckoning

With the Energy Future Holdings bankruptcy, leveraged buyouts now represent 31 percent of all bond and institutional loan defaults since 2007.
LBOs Face Their Day of Reckoning

Is the hangover from the leveraged buyout boom that took place prior to the financial crisis finally here? The bankruptcy filing of Energy Future Holdings has not only raised high-yield default rates for U.S. companies; it also means there have now been 10 LBO-related company defaults in 2014, one shy of the total for 2013.

The gargantuan failure of Energy Future Holdings — it represents the eighth largest bankruptcy of all time with $40.1 billion in pre-petition assets, as well as the largest LBO default to date — also pushed up the tally of loan and bond defaults associated with LBOs. With Energy Future Holdings defaulting on $35.8 billion in outstanding loans and bonds, there have now been $42.3 billion in bond and institutional loan defaults related to LBOs since 2007. That dollar amount represents 31 percent of total defaults from 2007 to the present, according to a new report from Fitch Ratings.

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The ability to refinance put off the day of reckoning for many of the big LBOs of 2004 to 2007. Momentive Performance Materials, another LBO that recently filed for bankruptcy, was bought in 2006 but refinanced the majority of its loans into bonds in 2010 to 2012, Fitch said. Momentive defaulted on $2.9 billion in debt when it declared bankruptcy in April.

There has been a pickup in high-yield issuer defaults generally in 2014, says Fitch. The trailing-12-month default rates for U.S. high yield debt and leveraged loans are now at 2.8 percent and 3.9 percent, respectively, both multi-year highs. As of the end of April there were 15 defaults on $22.4 billion in high-yield bonds, up from 13 defaults on $45.9 billion in the first third of 2013. Fitch pointed out that so far in May two high-yield issuers have defaulted: Allen Systems Group and River Rock Entertainment.

Despite the increase in defaults, investors are still hungry for speculative-grade bonds and loans, says Fitch. Seventy-three percent of corporate bonds rated ‘CCC’ or lower are trading above par, the ratings agency says. “The supply/demand imbalance has allowed issuers to extend maturities and lower their borrowing costs and this in turn has put downward pressure on the default rate. However, with $403 billion in ‘B–’ or lower rated bonds in circulation, the absolute level of credit risk in the market remains significant,” according to Fitch.

After Energy Future Holdings, which was bought by Kohlberg Kravis Roberts & Co., TPG and Goldman Sachs Capital Partners in 2007, the largest LBO defaults on high-yield debt the past seven years were Harrah’s, NewPage, Freescale Semiconductor, Momentive, Capmark Financial, Station Casino, Smurfit-Stone Container, Cengage Learning Acquisition and Nortek.

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