Rise in Default Rates Likely in 2013
Although default rates on leveraged loans remain extremely low, it’s not likely to last and an increase could start showing up as the economy heads into 2013, according to the latest Restructuring Quarterly Newsletter issued by Morgan Joseph TriArtisan (MJTA).
Based on a study of research into default rates in the corporate bank loan market and others, MJTA’s Restructuring Group said they showed generally a two- to three-year lag following issuance before they start to occur. Accordingly, it notes:
New debt issuances have risen sharply since 2008, and 2012’s pace is nearing 2006/2007 levels.
Overall debt volumes peaked in 2006-2007 and the default rate spiked two years later, though in part the result of the recession.
Historically low level of issuances in 2008-2009 has resulted in extremely low default rates in 2010-2011.
However, new leveraged loans and high yield issuance is up sharply since 2010, and this year’s volume has already surpassed 2011 levels.
“Defaults are coming,” concludes James D. Decker, head of the Restructuring Group:
“If past relationships continue to hold, and the reports we reviewed strongly suggest they usually do, the ongoing rise in loan volume suggests that default rates will rise as we move into the new year.”
Among other financing and restructuring trends, the MJTA report notes:
The 2012 third quarter marked a post-Lehman low water mark for equity contributions to leveraged buyouts on the whole. The average deal required just 38% equity capitalization, compared with the 40 to 50% levels experienced in 2008-2011.
Competition for ABL (asset based loans) remains fierce. “However, a number of market participants claim that bank structures and pricing seem to have stabilized at current levels.” Pricing of ABL loans floated slightly higher in the third quarter to an average spread to LIBOR just north of 200 bps. The increase in pricing may reflect a growing willingness of lenders to offer term facilities often at prices at a premium to the revolving working capital component.
Cash flow senior lending has become generally available in leverage levels as high as the three to four times range for middle-market borrowers with minimum EBITDA in the $15 to $20 million range with strong operating trends. Sub-$15 million EBITDA borrowers remain largely uncovered by senior lenders. When they do, they often must turn to second lien lenders positioned to lend to smaller or storied borrowers on a senior basis. The MJTA team reports seeing numerous funds willing to provide these companies with uni-tranche facilities that are highly competitive with more traditional ABL+second lien structures, but it usually requires a thorough placement process to fully access this capital.