1 Dr Edward Altman NYU Stern School of Business How Risky are Private Equity Sponsored LBOs MacQuarie University Sydney Australia November 09 2015 Research Objectives To assess the default and loss rate on PESponsored LBOs ID: 467847
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Dr. Edward Altman
NYU Stern School of Business
How Risky are Private Equity Sponsored LBOs
MacQuarie
University
Sydney, Australia
November 09, 2015Slide2
Research Objectives
To assess the default and loss rate on PE-Sponsored LBOs To analyze the default risk of PE-Sponsored LBOs compared to comparably rated corporate bonds
Null Hypothesis: That the LBO mortality (Default) Rate is the same as the rate on comparably rated corporate bonds The first study to utilize the mortality rate concept to analyze the Leveraged Buy-Out market over the last 20 years; no migration bias
The study utilizes two unique databases: (1) an institutional loan-based LBO database; (2) a comprehensive loan and bond default database matched to the LBO sampleSource of LBO transaction data: S&P LCD; Source of default data: NYU Salomon Center Master Default, Chapter 11 Filings & Defaulted Securities Pricing Databases
In addition to LBO default rate estimates, we also explore investor loss estimates; Investor returns not available
2Slide3
Sample Characteristics
Sample of U.S. Dollar LBOs includes only those large, highly-leveraged financed transactions that involve institutional loan issuance
A total of 747 individual PE-sponsored LBOs analyzed, consisting of 980 loan issues Involving LBOs from December 1994 through April 2012
Involving 862 observations stratified by their implied bond rating (IBR) or by their original S&P loan rating (OLR) (it’s possible that a single issuer had multiple loans at different implied & original ratings)
Total dollar amount of loan issuance equaled $592 billionMean
loan size $604 million; median loan size $270 million
IBR based on a 2-notch reduction from the original loan rating
Default incidence Defaults include bankruptcies, missed interest payments, & distressed exchangesTotal number of individual LBO defaults equals 126
Total number of defaults by IBR equals 145 Total loan dollar amount of defaults equals $150 billion
Largest defaulters: TXU, Clear Channel, Caesars and Tribune 3Slide4
Mortality Rate Methodology
4Slide5
5
Marginal and Cumulative Mortality Rate Actuarial Approach
One can measure the cumulative mortality rate (CMR) over a specific time period (1,2,…, T years) by subtracting the product of the surviving populations of each of the previous years from one (1.0), that is,
MMR(r,t)
=
total value of defaulting
debt from rating (r) in year (t)total value of the population at the start of the year (t)
MMR = Marginal Mortality Rate
CMR
(r,t) = 1 -
SR(r,t)
,t = 1 Nr = AAA CCC
here CMR
(r,t) = Cumulative Mortality Rate of (r) in (t), SR (
r,t) = Survival Rate in (r,t) , 1 - MMR (r,t)Slide6
6
Mortality Rate Concept(Illustrative Calculation)
For BB Rated Issues
Security Issued Year 1 Year 2
No. Amount Default Call SF Default Call SF
1 50 -- -- 5 -- -- 5
2 50 50 -- -- NE
NE NE
3 100 -- 100 -- NE NE NE
4 100 -- -- -- 100 -- --
5 150 -- -- -- -- -- 15
6 150 -- -- -- -- -- --
7 200 -- -- 20 -- -- 20
8 200 -- -- -- -- 200 -- 9 250 -- -- -- -- -- --
10 250 -- -- -- -- -- -- Total 1,500 50 100 25 100 200 40
Amount
Start of 1,500 175 1,325 340 985
Period
- - - =
Year 1 Year 2
Marginal
Mortality 50/1,500 = 3.3% 100/1,325 = 7.5%
Rate
1 - (SR1 x SR2 ) = CMR2
Cumulative Rate 3.3% 1 - (96.7% x 92.5%) = 10.55%
NE = No longer in existence
SF = Sinking fundSlide7
7
All Rated Corporate Bonds*
1971-2014
Mortality Rates by Original Rating
*Rated by S&P at Issuance
Based on
2,847
issues
Source: Standard & Poor's (New York) and Author's Compilation
Years After IssuanceSlide8
8
All Rated Corporate Bonds*
1971-2014
Mortality Losses by Original Rating
*Rated by S&P at Issuance
Based on
2,354
issues
Source: Standard & Poor's (New York) and Author's Compilation
Years After IssuanceSlide9
Empirical Findings
9Slide10
Number of Issuers
BB230
B547CCC/CC
84Total
861
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By Original Loan Rating (OLR)
By Implied Bond Rating (IBR)
BB15B
539CCC/CC
308Total
862Slide11
Number of Defaulted Issuers by Years After Issuance
Years After
Issuance to Default
1
2
3
4
5
6
7
8
9
10
Totals
BB1464342
531
33
B
3
10
21
19
19
10
3
8
5
1
99
CCC/CC
1
4
4
5
1
3
18
Totals
4
15
31
27
30
14
6
16
8
2
150
11
By
Original Loan Rating (OLR)
Years After
Issuance to Default
1
2
3
4
5
6
7
8
9
10
Totals
BB
1
1
B
2
10
17
16
13
11
3
9
7
2
90
CCC/CC
2
6
10
10
12
3
3
7
154Totals4162826251461682145
By
Implied Bond Rating (IBR)Slide12
Cumulative Mortality (Default) Rates by Dollar Amount (U.S.) Based on IBR
1
2
34
56
78
9
10BB0.00%
0.00%22.99%*22.99%
22.99%22.99%
22.99%22.99%
22.99%22.99%
B1.86%
5.52%14.27%15.65%16.69%
17.65%17.83%21.25%22.42%22.58%CCC/CC11.82%
18.82%24.91%27.31%
30.21%30.56%
34.03%
34.81%
35.91%
35.91%
For LBOs by
Implied Bond Rating
(
IBR)
at Issuance (1995-2014) – Mortality Rates
For High-Yield Bonds by
Original Bond Rating
at Issuance (1971-2014)** - Mortality Rates
1
2
3
4
5
6
7
8
9
10
BB
0.95%
2.96%
6.75%
8.58%
10.73%
12.10%
13.39%
14.37%
15.61%
18.27%
B
2.86%
10.38%
17.42%
23.87%
28.22%
31.42%
33.86%
35.24%
36.39%
36.87%
CCC
8.15%
19.58%
33.99%
44.78%
47.37%
53.43%
55.97%
58.11%
58.40%
60.19%
12
**from: E. Altman and B. Kuehne “Defaults and Returns in the High-Yield Bond and Distressed Debt Market: The Year 2014 in Review and Outlook”,
Paulson and Co.
and the
NYU Salomon Center
, January 30, 2015.
*from 1 large Distressed Exchange by
Freescale
Semiconductor.Slide13
Cumulative Mortality (Default) Rates by Number of Issuers (U.S.) Based on IBR
1
2
34
56
78
9
10BB0.00%
0.00%6.67%6.67%
6.67%6.67%
6.67%6.67%
6.67%6.67%
B0.37%
2.23%5.45%8.59%11.23%
13.56%14.21%16.22%17.81%18.27%CCC/CC0.65%2.60%
5.96%9.39%13.61%
14.70%15.82%
18.47%
18.85%
18.85%
For LBOs by
Implied Bond Rating
(
IBR)
at Issuance (1995-2014) – Mortality Rates
For High-Yield Bonds by Bond Rating (1981-2013)* - Default Rates
1
2
3
4
5
6
7
8
9
10
BB
0.87%
2.69%
4.90%
6.98%
8.83%
10.65%
12.18%
13.56%
14.84%
15.96%
B
4.23%
9.62%
14.26%
17.91%
20.73%
23.03%
24.94%
26.45%
27.76%
29.01%
CCC/C
27.98%
38.53%
44.43%
48.25%
51.25%
52.52%
53.76%
54.67%
55.82%
56.58%
13
*from: “Default, Transition, and Recovery: 2013 Annual Global Corporate Default Study and Rating Transitions”,
Standard &
Poors
Ratings Direct
, March 19, 2014.Slide14
Cumulative Mortality Rates for LBOs Based on OLR at Issuance (U.S.)
1
2
34
56
78
9
10BB3.10%
4.19%8.96%9.80%
10.31%11.07%
11.22%15.78%
16.61%16.75%
B5.36%
12.27%23.70%25.78%27.79%
28.61%30.23%31.45%32.83%32.93%CCC/CC0.00%
0.90%4.85%7.82%
13.77%13.77%15.08%
17.23%
17.23%
17.23%
By Dollars
By Number of Issuers
1
2
3
4
5
6
7
8
9
10
BB
0.43%
2.17%
4.87%
6.72%
8.15%
10.09%
11.07%
13.56%
15.09%
15.60%
B
0.55%
2.38%
6.31%
10.00%
13.80%
15.90%
16.56%
18.35%
19.47%
19.70%
CCC
0.00%
1.19%
6.13%
11.20%
17.83%
17.83%
19.22%
23.40%
23.40%
23.40%
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Cumulative Mortality Losses by Dollar Amount
1
2
34
56
7
89
10BB
0.00%0.00%19.65%*
19.65%19.65%
19.65%19.65%19.65%
19.65%19.65%
B0.12%
1.54%5.50%6.63%7.48%
7.80%7.98%9.71%10.44%10.52%CCC/CC5.18%
12.02%15.71%17.39%
18.71%18.74%
20.92%
21.44%
21.44%
21.44%
For LBOs
by Implied Bond Rating (IBR)
at Issuance
For High-Yield Bonds by
Original Bond Rating
at Issuance (1971-2014)*
1
2
3
4
5
6
7
8
9
10
BB
0.56%
1.73%
3.99%
5.07%
6.33%
7.02%
7.75%
8.20%
8.88%
9.89%
B
1.92%
7.23%
12.18%
16.76%
19.90%
21.86%
23.68%
24.56%
25.26%
25.65%
CCC
5.38%
13.61%
24.45%
33.14%
35.36%
40.95%
43.36%
45.28%
45.51%
47.01%
15
*from: E. Altman and B. Kuehne “Defaults and Returns in the High-Yield Bond and Distressed Debt Market: The Year 2014 in Review and Outlook”,
Paulson and Co.
and the
NYU Salomon Center
, January 30, 2015.
*from 1 large Distressed Exchange by
Freescale
Semiconductor.Slide16
Cumulative Default Rates by Number of Issuers (Europe)
For High-Yield Bonds by Bond Rating (1981-2013)*
1
23
45
6
7BB
0.57%1.76%2.93%
3.69%4.63%5.68%6.73%
B3.30%
8.26%12.28%
14.81%16.62%
17.81%18.26%
CCC/C31.76%38.10%40.01%
41.16%42.84%42.84%44.96%16
*from: “Default, Transition, and Recovery: 2013 Annual Global Corporate Default Study and Rating Transitions”, Standard & Poors Ratings Direct, March 19, 2014.Slide17
Conclusions
17 Summary Default Statistics for PE-Sponsored LBOs from 1995-2014
(Leveraged Loan Transactions): Number of Individual LBO Defaults: 126 Number of Issuer Defaults by Original Loan Rating: 150
Dollar Amount of Defaults: $150 billion Default Statistics Within 5 Years of Original Transaction Date 11.2% of Individual LBOs Defaulted 12.1% (13.6% ,including exits) of the Number of LBO Loan Issues Defaulted
11.5% (12.9%, including exits) of all LBOs defaulted by Implied Bond Ratings 20.1% (21.2% , including exits) of all LBOs defaulted by Loan Dollar Amount
Private Equity Sponsored LBOs had Significantly
Lower Cumulative Mortality (Default) Rates than did Comparably Rated Corporate Bonds over the Last Two Decades Similar Results for Default LossesSlide18
Remarks
18
Possible Positive Reasons for Lower Default Rates, and Losses, on PE-Sponsored LBOs compared to Comparably Rated Corporate Bonds: Greater Access to Capital by PE-Sponsored LBOs Greater Funds to Support Ailing Companies Better Portfolio Management and Management Support Techniques than Stand-Alone Companies
Better and Cheaper Access to Traditional and “Shadow Banking” Funds LBO Management More Heavily Invested in Success; More “Skin in the Game”
Private Firm versus Public Firm Flexibility Rating Agency Bias in Rating LBOs?
Possible Negative Reasons for Higher Default Rates and Losses: Asset Stripping (Crown Jewels) to Repay Debt (Could Work Both Ways)
Subsequent Debt Issuance to Pay-out Dividends to Owners Rating Agency Bias in Rating LBOs?Slide19
Current Lbo and Default statistics
19Slide20
Straight Bonds Only Excluding Defaulted Issues From Par Value Outstanding, (
US$ millions),
1971 – 2015 (10/15))
Historical
H.Y. Bond Default Rates
20
Year
Par Value
Outstanding
a
($)
Par Value
Defaults ($)
Default Rates
(%)
2014
1,496,814
31,589
2.110
2013
1,392,212
14,539
1.044
2012
1,212,362
19,647
1.621
2011
1,354,649
17,963
1.326
2010
1,221,569
13,809
1.130
2009
1,152,952
123,878
10.744
2008
1,091,000
50,763
4.653
2007
1,075,400
5,473
0.509
2006
993,600
7,559
0.761
2005
1,073,000
36,209
3.375
2004
933,100
11,657
1.249
2003
825,000
38,451
4.661
2002
757,000
96,855
12.795
2001
649,000
63,609
9.801
2000
597,200
30,295
5.073
1999
567,400
23,532
4.147
1998
465,500
7,464
1.603
1997
335,400
4,200
1.252
1996
271,000
3,336
1.231
1995
240,000
4,551
1.896
1994
235,000
3,418
1.454
1993
206,907
2,287
1.105
1992
163,000
5,545
3.402
1991
183,600
18,862
10.273
1990
181,000
18,354
10.140
1989
189,258
8,110
4.285
1988
148,187
3,944
2.662
a
Weighted by par value of amount outstanding for each year.
Year
Par Value Outstanding* ($)
Par Value
Defaults ($)
Default
Rates
(%)
1987
129,557
7,486
5.778
1986
90.243
3,156
3.497
1985
58,0889921.708198440,9393440.840198327,4923011.095198218,1095773.186198117,115270.158198014,9352241.500197910,356200.19319788,9461191.33019778,1573814.67119767,735300.38819757,4712042.731197410,8941231.12919737,824490.62619726,9281932.78619716,602821.242
Standard Deviation (%)Arithmetic Average Default Rate (%)1971 to 20143.1173.0971978 to 20143.3403.2731985 to 20143.8433.416Weighted Average Default Rate (%)*1971 to 20143.4911978 to 20143.4961985 to 20143.513Median Annual Default Rate (%)1971 to 20141.664
Source: Author
’s compilation and Citigroup/Credit Suisse estimates
2015 (10/15)
1,595,839
35,414
2.219Slide21
Quarterly Default Rate and Four-Quarter Moving Average
1989 –
2015 (3Q - Preliminary)
Source: Author’s Compilations
Default Rates on High-Yield Bonds
21Slide22
Historical Default Rates and Recession Periods in the U.S.
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Periods of Recession: 11/73 - 3/75, 1/80 - 7/80, 7/81 - 11/82, 7/90 - 3/91, 4/01 – 12/01, 12/07 - 6/09
*All rates annual, except 3Q 2015 which is the LTM.
Source: E. Altman (NYU Salomon Center) & National Bureau of Economic Research
High-Yield Bond Market (1972
– 2015 (3Q - Preliminary)) Slide23
23
Source: S&P Capital IQ LCD
Purchase Price Multiple excluding Fees for LBO Transactions
Purchase Price Multiples
N/A
(# obs.)
N/ASlide24
24
Average Total Debt Leverage Ratio for LBO’
s: Europe and US with EBITDA of €/$50M or More
Source: S&P Capital IQ LCDSlide25
25
Maturity Profile of Leveraged Debt – As of 12/31/14
Source: S&P Capital IQ LCD