PE-Backed Leveraged Loan Issuers Eye Rising Costs and Outsized Risks Amid Further Hikes

Private equity-backed companies, representing more than 60% of the Morningstar LSTA U.S. Leveraged Loan Index, have helped drive the decade-long growth of the $1.44 trillion leveraged loan market.

But now that the regime change from near-zero interest rates is fully underway, these sponsor-backed companies account for almost all of the riskiest (and therefore most expensive) leveraged loans in the US. You will have to adapt to the rising interest cost of this variable rate debt.

In this analysis, LCD looks at sponsor company status and the Leveraged Loan Index. Heading:

  • 90% of loans are rated B-minus or lower sponsor companies.
  • Investors request an additional 111 bps to hold sponsored loans in the secondary market.
  • During bankruptcy waves, PE loan default rates are low.

Cliff?
One of the most obvious data points when digging into the index is found in the ratings compilation. LCD data shows that companies backed by private equity sponsors account for a staggering 90% of index loans with a loan rating of B-minus or below by S&P Global Ratings.

Firms majority-owned by private equity funds are not required to publicly file financial reports or disclose material impact on their operations, yet account for 92% of all B-rated indexed loans . Of course, this is just one downgrade from the effectively dangerous triple C rung on the rating ladder. In the highly speculative share of the loan index, 82% of CCC+ rated loans and 85% of CCC flat loans are made through sponsor-backed companies.

As a share of the overall index, B- and low-rated loans from corporate sponsors accounted for nearly 27% of the $1.4 trillion in loans outstanding. This compares to his 3% for unsponsored entities.

Of course, this observation in the secondary market is because leveraged buyout funding in the primary market has increasingly moved into the B-minus bucket in recent years. More than half of his leveraged loans raised to finance buyouts in 2019 were from borrowers who, at least, he was rated B-minus by one rating agency. Year-to-date, this share has risen from an average of about 55% over the past three years to a record high of 68%.

It is not surprising that the sponsored companies funding the initial issue market actually boast much higher leverage levels of 1.5x.

According to LCD data, sponsored transactions (excluding refinancing) utilized 6x leverage at issuance in 2022 and 5.9x in 2021.

Unsponsored companies pioneered the new issue market with an average debt to EBITDA of 4.4x in 2022 and 2021.

deadline is approaching
Another profiling of risk is when these loans need to be repaid. The LCD data shows that both sponsors and non-sponsors took advantage of the cheap and readily available bond market to refinance and extend institutional investors’ term his loans.

Only 8% of outstanding sponsored loans will be due between now and the end of 2024. This is similar to 9% of all outstanding sponsored loans.

Note, however, that if the loan becomes due within 12 months, the loan will be marked as current on the balance sheet. The next big leap in sponsorship maturity is his $70 billion due in 2024.

In absolute terms, sponsor companies will have $209 billion in institutional loans by the end of 2025, compared to $117 billion for non-sponsor companies.

Paying
Looking at the market price of this debt, LCD Data shows that the price of leveraged loans backing unsponsored companies averaged 111 bps higher at 97.28 over the five years ending Sept. 30. . 96.17 For sponsored and generally low-rated opponents.

However, on Sept. 30, the gap exceeded 200 bps as investors continued to seek safety from higher rated facilities. The divergence between the two cohorts is the largest since May 2020.

For reference, the gap between sponsored and non-sponsored loans widened by nearly 450 bps during the pandemic market crash in March 2020, and by 580 bps in March 2009 as loan defaults spiked. Did.

As of September 30, when looking at the corresponding underlying nominal spreads, sponsor companies are on average 91 bps higher, 390 bps above the benchmark rate.

Looking at how default activity has evolved between private and public companies, LCD data shows a recent rise in defaults in the aftermath of the 2020 crash and rising oil prices in 2016. Indicates that the sponsoring company defaulted during the period. Lower rates than unsponsored entities. Conversely, outside of these periods, sponsor companies generally exhibit higher default activity than listed companies.

However, one big caveat is that the LCD criteria do not include distressed exchanges. The exchange is likely to retain the equity interest and control of the company held by his private equity holder, which is particularly problematic for his PE firm during market downturns.

In terms of long-term payment defaults and bankruptcies, the average default rate for private equity-backed loans since 2011 (at the beginning of the tracking data series by number of issuers) is roughly comparable to the sponsor company’s 1.50%. Unsponsored he is 1.57%.

Again, adding problematic exchanges will increase this rate, but losses from problematic exchanges are usually much less. LCD’s analysis of S&P Global Market Intelligence’s LossStats database found that through a 34-year history of LossStats data, the discounted recovery rate for term loans that defaulted through the bankruptcy process was 68.9%, compared to 68.9% for distressed exchanges. 89.8% of him is shown.

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