Moody’s: Quarter of unrated European LBOs risk default

Thanks to a buoyant high-yield market, the overall refinancing burden of unrated PE-backed companies has largely decreased – but the weakest borrowers remain highly vulnerable, says the rating agency.

Record high-yield issuance has helped European portfolio companies reduce their debt burden, according to Moody’s. 

In a report released this week, the rating agency found that the sound health of corporate bond markets has allowed many European portfolio companies to refinance existing maturities, with the total unrated debt load now down to €122 billion from €171 billion last year. 

In addition, the agency said, improved financing conditions have allowed for a ‘flattening’ of the previous 2014 to 2015 refinancing peak: around 44 percent of LBO unrated debt now matures after 2015, double the 22 percent found in last year’s study. 

This was largely driven by a boom in high-yield bond issuance, which totalled $60 billion on the year to end May for speculative grade companies. That compared with $70 billion issued for the whole of 2012, which itself was already a record.

“The easing of the refinancing burden reflects the ability of many highly leveraged, usually medium sized, companies, to benefit from recent extraordinary market appetite for high-yield bonds to refinance their loans,” commented Sebastien Cieniewski, an assistant vice-president at Moody’s and author of the report, in a statement. 

The easing of the refinancing burden reflects the ability of many highly leveraged, usually medium sized, companies, to benefit from recent extraordinary market appetite for high-yield bonds

Sebastien Cieniewski

The trend was not deemed to hold true across the board, however.  The report stressed that the bulk of refinancing transactions had been completed by companies with better credit profiles.

As a result, it said, the deleveraging of the best-in-class has actually led to a concentration of weaker companies in the unrated credit space: 70 percent of European LBO debt maturing through 2015 is now rated at 16 or weaker – a level at which an asset is deemed “speculative and subject to high risk” – compared to 55 percent in 2012. 

The agency thus expected default rates to climb in months to come, with up to a quarter of companies loaded with unrated debt possibly missing on repayment obligations in 2014-2015. The figure could drastically increase if high yield bond markets were to shut in the near future, it said, an eventuality with a low level of probability but made more possible by the shift in stance displayed by Western central bankers over recent weeks. 

The massive purchases of top-rated securities by the Fed, the ECB and the Bank of England, an operation dubbed quantitative easing, has so far been a major factor behind the surge in issuance of high-yield securities, Moody’s explained. But indications that the Fed is planning to roll back such policies on the back of an improving economy have led to a rapid increase in bond yields, eventually making the issuance of new debt on capital markets more expensive.