Lenders Take Comfort In Lower Levels Of Distress

Signs in the leveraged lending market remained positive last month as the level of sponsor-backed defaults remained low and the distressed debt ratio saw meaningful evaporation.

“As long as we continue to have economic stability, lender confidence should continue to build,” said Tom Gregory, a managing director at lower mid-market lender Maranon Capital. Gregory added that he’s seeing lower pricing on debt and higher leverage multiples on new deals.

The U.S. sponsor universe saw no debt-related portfolio company defaults in April, representing an absolute turnaround from the same month in the previous year, which had been the peak of the LBO default boom. At least 14 sponsor-backed companies defaulted in April 2009, according to Buyouts’s analysis of Standard & Poor’s data.

Through the end of April, the year-to-date count of U.S. portfolio companies that fell into default stood at seven, a 78 percent drop from the 32 such defaulters during the same period in 2009.

The ratio of speculative-grade debt considered to be in distress has also continued to ease as the turmoil of 2009 fades into memory. As of April 15, the S&P’s distress ratio fell to 6.7 percent ($32 billion) from 9.7 percent ($47.7 billion) in mid-March.

A distressed credit, in the eyes of S&P, is speculative-grade debt (rated ‘BB+’ or lower) that trades at spreads of more than 1,000 bps relative to treasuries. To calculate its distress ratio, S&P divides the number of distressed credits by the total number of speculative issuances. The current distress ratio is less than half of the S&P’s long-term average of 15.9 percent, and is nearly 13 times less than the record high of 85.2 percent reached in December 2008, according to the ratings agency.

That said, buyout-backed companies continue to account for a significant portion of today’s distressed credits. First Data Corp., the credit card processor backed by Kohlberg Kravis Roberts & Co., is on S&P’s list with about $5.8 billion in distressed credits. Clear Channel Communications Inc., bought by Bain Capital and Thomas H. Lee, is said to have approximately $2.82 billion distressed credits on its balance sheet. Dollar-wise, these two companies make up about 27 percent of the U.S. distressed debt as tracked by S&P.

Smaller companies are no exception, either. Perkins & Marie Callender’s Inc., a Castle Harlan-backed restaurant operator, is strapped with about $322 million of distressed debt, while Claire’s Stores Inc., an Apollo Management-owned retailer of teen fashion accessories, has about $307 million of troubled credits on its books, according to S&P.

The downward trajectory of drama in the U.S. credit markets has no doubt been noticed by lenders, at least in the lower mid-market. Pricing on senior cash flow for companies with EBITDA of $10 million to $30 million stands between L+450 bps to L+525 bps, down from the year-ago range of L+650 to L+700, Maranon’s Gregory said. Libor floors have also been scaled back over that same period to between 150 bps and 175 bps from 300 bps.

“Part of the aggressive senior pricing we’re seeing today is perhaps because lender confidence is back before a wholesale resurgence in M&A transaction flow,” Gregory said. “There’s more lender comfort than there are deals to invest in,” he added. “We think that will rectify itself as we push through the year.”