It’s no secret that the leveraged loan market has been on hiatus since 1999 with no signs of recovery anywhere in the near future. But even bigger problems are on the horizon – more and more companies are defaulting on their loans, and lenders are becoming less and less patient.
According to data from S&P’s Portfolio Management Data, loans made to highly leveraged companies are down by more than a third from last year. Also, the research group’s new index of 500 key non-investment-grade loans shows that overall return on loans fell 1.52% in September. That is two times the decline of 0.74% the month after the 1998 Russian default crisis, or the 0.75% decline during the Asian crisis of 1999.
Furthermore, a look at institutional loans closed between 1995 and Q3 2001 for issuers that filed publicly indicates that the retail food and drug, environmental, entertainment and leisure, manufacturing and machinery and consumer nondurables industries saw the highest concentration of loan defaults. This means two things for buyout firms more companies need rescuing, but at the same time companies in their current portfolios could be struggling.
While many GPs would rather not talk about whether or not their portfolio companies are defaulting on their loans, they say the companies coming to market are not necessarily attractive. They’re just being put on the selling block because lenders want their money back. “One thing that is interesting is that banks are forcing companies to go to market because they think that they can get 100% of their debt paid off,” said Robert Newbold, a partner at Graham Partners, a firm that is bullish on the manufacturing and building materials industries. “Let’s say a bank levered a company up at three times Ebitda and that company’s Ebitda falls by half. If the banks think they can sell the business for six times Ebitda, then they’ll force them to sell and whoever owns that company ends up losing their equity. Ironically, if the company’s Ebitda drops to one-third and the banks have to sell it for nine times Ebitda to get their debt paid, then they’ll wait it out.”
But the bad news doesn’t stop there. Moody’s Investors Service has, in the first nine months of 2001, downgraded five times as many borrowers as it has upgraded – the most negative ratio since loan ratings were initiated in 1995. And a government annual review of the quality of banks’ syndicated loans revealed that the sum of “bad” loans during May and June 2001 stood at $117 billion, or 5.7% of total loans, which is up from 3.2% for 2000.
However, there may be some help along the way for downtrodden companies. A day after the attacks, the Office of Comptroller of the Currency released a statement encouraging national banks to “work with customers” affected by the attacks. The agency urged banks to consider such alternatives as extending the terms of loan payments. Agere Systems, a maker of semiconductors and optical components, was the beneficiary of that this month announced that its banks had agreed to defer payment on $1.5 billion of a $2.5 billion loan. The loan, which was scheduled to mature in February 21, 2002, will now be due September 30, 2002, the company said.
Sources also say that the aggressive interest rate cuts by the Federal Reserve are also taking some of the pressure off of companies in terms of the cost of borrowing in the near-term. “At the end of the day, it will have a stimulative affect on the economy and activity,” said Ken Kencel, co-founder of newly formed RBC Leveraged Finance Group.