Moody’s: PE sponsors ‘cheating death’

Firms have achieved higher recoveries and maintained control over defaulted portfolio companies through distressed debt exchanges, according to a new report.

Private equity-backed companies that verged close to debt collapse in the downturn appear to have weathered the default storm by avoiding bankruptcy and exchanging debt, according to a new report from Moody’s Investors Service.

Distressed debt exchanges, in which debt holders may be forced to accept securities of lower value for their debt claims, have generally given private equity firms higher recoveries and allowed them to protect equity, Moody’s said.

Fears that mega-funds would pile tons of debt on their acquisitions, suck cash out to pay themselves and walk away once the debt became distressed, were unfounded, the report said.

“Although private equity’s predilection for leverage at the height of the credit bubble and the ravages of the subsequent economic downturn put many of their companies into default, these firms have weathered the storm,” Moody’s said in the report, called “Cheating Death”.

“Although these companies remain vulnerable to subsequent defaults, at this point it appears that private equity-backed companies have successfully navigated the worst of the current default cycle,” the rating analyst said.

Although these companies remain vulnerable to subsequent defaults, at this point it appears that private equity-backed companies have successfully navigated the worst of the current default cycle.

Moody's Investors Service

The distressed exchanges are preferable to bankruptcy for private equity because it leaves the firms with some semblance of control, Moody’s said.

Some large distressed exchanges this year included Apollo and TPG-backed Harrah’s Entertainment, which has cut more than $4 billion of debt through exchanges and other means, and Freescale Semiconductor, backed by Carlyle, Blackstone, TPG and Permira, has knocked more $2 billion off its debt load through exchanges.

Those firms that did choose bankruptcy outperformed companies not backed by a sponsor when entering “pre-packaged” bankruptcy, Moody’s said. Under a “pre-packaged” bankruptcy, sponsors reach agreements with most creditors and draft a plan of reorganisation before entering Chapter 11.

Bank debt also has been a driver of recovery for private equity-backed companies, according to the report. Of the 62 private equity-backed companies in default, 60 had bank debt. Twenty-three of the companies with bank debt also had some form of subordinated debt like second liens.

At the 23 private equity-backed companies employing subordinated tranches of debt, recoveries averaged nearly 85 percent for the first-lien debt holders, Moody’s said. The subordinated tranches combined had recoveries of about 42 percent. And with the “cushion” of non-bank debt like mezzanine, subordinated tranches had even higher recoveries of about 61 percent, the report said.

Recoveries of senior unsecured bonds on private equity-backed companies have been lower than bank debt recoveries, typically because the bonds are used as the junior most debt in the capital structure, Moody’s said.