Study: Flood of PE-backed defaults unlikely

The Private Equity Council, a lobbying group representing some of the biggest private equity firms, has found that private equity backed companies have fared better in the recession than non-sponsored companies.

The annualised default rate for more than 3,200 private equity-backed companies bought between 2000 and 2009, and held through 2008- 2009, was 2.8 percent during the two-year recession, according to the PEC study released Wednesday. The rate for “comparable businesses” was 6.2 percent, the PEC said.

Additionally, the study found that the defaults “tended to correlate” to overall economic activity. Media companies and auto supply companies – both affected by general industry downturns – were “overrepresented” in the default group.

“It is highly unlikely that the cumulative default rate of private equity acquisitions will approach anything close to the highs feared by critics,” the PEC said.

Private equity ownership during times of trouble is often superior to that of other owners. Private Equity Council

The report defines “default” as a missed payment or bankruptcy filing.

PEC does not explain why default rates for private equity firms are lower than anticipated, but does expect the rates to continue to fall as overall default rates in the markets decline, which Moody's is forecasting.

“Given that portfolio companies’ default rates generally cluster in a manner that tracks those of the broader economy, the Moody’s forecast suggests that they should decline in 2010 as well,” PEC said. “While challenges remain and future defaults are inevitable, it is highly unlikely that the cumulative default rate of private equity acquisitions will approach anything close to the highs feared by critics.”

A spokesperson for the PEC said the lower default rates among private equity-backed companies could be attributed to the “operational expertise” and “alignment of interest” that comes with private equity ownership. “Private equity ownership during times of trouble is often superior to that of other owners,” the spokesperson said.

The PEC takes issue with several recent reports showing default rates for private equity companies are higher than for other companies. One of the reports was issued in late 2008 by the Boston Consulting Group and forecasted nearly half the world’s private equity-backed companies would default in the next three years. The consulting group also predicted that up to 40 percent of large buyout firms around the world could go out of business in the next few years.

“[The BCG forecast] appears to have significantly overstated the problem,” the PEC said. “Data show that cumulative defaults are running at a rate that is approximately 30 percentage points below that predicted by the BCG.”