1 111 Dr. Edward Altman NYU Stern School of Business How Risky are Private Equity Sponsored LBOs...
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Transcript of 1 111 Dr. Edward Altman NYU Stern School of Business How Risky are Private Equity Sponsored LBOs...
1111
Dr. Edward AltmanNYU Stern School of Business
How Risky are Private Equity Sponsored LBOs
MacQuarie UniversitySydney, AustraliaNovember 09, 2015
2
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 sample
•Source 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
3
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 billion• Mean 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 exchanges
• Total 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
4
MORTALITY RATE METHODOLOGY
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 N
r = AAA CCChere CMR (r,t) = Cumulative Mortality Rate of (r) in (t),
SR (r,t) = Survival Rate in (r,t) , 1 - MMR (r,t)
6
Mortality Rate Concept(Illustrative Calculation)
For BB Rated Issues
Security Issued Year 1 Year 2No. Amount Default Call SF Default Call SF
1 50 -- -- 5 -- -- 52 50 50 -- -- NE NE NE3 100 -- 100 -- NE NE NE4 100 -- -- -- 100 -- --5 150 -- -- -- -- -- 156 150 -- -- -- -- -- --7 200 -- -- 20 -- -- 208 200 -- -- -- -- 200 --9 250 -- -- -- -- -- --
10 250 -- -- -- -- -- --
Total 1,500 50 100 25 100 200 40
AmountStart of 1,500 175 1,325 340 985Period
- - - =
Year 1 Year 2MarginalMortality 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 existenceSF = Sinking fund
7
All Rated Corporate Bonds*1971-2014
Mortality Rates by Original Rating
*Rated by S&P at IssuanceBased on 2,847 issues
Source: Standard & Poor's (New York) and Author's Compilation
Years After Issuance
8
All Rated Corporate Bonds*1971-2014
Mortality Losses by Original Rating
*Rated by S&P at IssuanceBased on 2,354 issues
Source: Standard & Poor's (New York) and Author's Compilation
Years After Issuance
9
EMPIRICAL FINDINGS
10
Number of Issuers
BB 230
B 547
CCC/CC 84
Total 861
By Original Loan Rating (OLR)
By Implied Bond Rating (IBR)BB 15
B 539
CCC/CC 308
Total 862
11
Number of Defaulted Issuers by Years After Issuance
Years After Issuance to Default
1 2 3 4 5 6 7 8 9 10 Totals
BB 1 4 6 4 3 4 2 5 3 1 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
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 1 54
Totals 4 16 28 26 25 14 6 16 8 2 145
By Implied Bond Rating (IBR)
12
Cumulative Mortality (Default) Rates by Dollar Amount (U.S.) Based on IBR
1 2 3 4 5 6 7 8 9 10
BB 0.00% 0.00% 22.99%* 22.99% 22.99% 22.99% 22.99% 22.99% 22.99% 22.99%
B 1.86% 5.52% 14.27% 15.65% 16.69% 17.65% 17.83% 21.25% 22.42% 22.58%
CCC/CC 11.82% 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%
**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.
13
Cumulative Mortality (Default) Rates by Number of Issuers (U.S.) Based on IBR
1 2 3 4 5 6 7 8 9 10
BB 0.00% 0.00% 6.67% 6.67% 6.67% 6.67% 6.67% 6.67% 6.67% 6.67%
B 0.37% 2.23% 5.45% 8.59% 11.23% 13.56% 14.21% 16.22% 17.81% 18.27%
CCC/CC 0.65% 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%
*from: “Default, Transition, and Recovery: 2013 Annual Global Corporate Default Study and Rating Transitions”, Standard & Poors Ratings Direct, March 19, 2014.
14
Cumulative Mortality Rates for LBOs Based on OLR at Issuance (U.S.)
1 2 3 4 5 6 7 8 9 10
BB 3.10% 4.19% 8.96% 9.80% 10.31% 11.07% 11.22% 15.78% 16.61% 16.75%
B 5.36% 12.27% 23.70% 25.78% 27.79% 28.61% 30.23% 31.45% 32.83% 32.93%
CCC/CC 0.00% 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%
15
Cumulative Mortality Losses by Dollar Amount
1 2 3 4 5 6 7 8 9 10
BB 0.00% 0.00% 19.65%* 19.65% 19.65% 19.65% 19.65% 19.65% 19.65% 19.65%
B 0.12% 1.54% 5.50% 6.63% 7.48% 7.80% 7.98% 9.71% 10.44% 10.52%
CCC/CC 5.18% 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%
*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.
16
Cumulative Default Rates by Number of Issuers (Europe)
For High-Yield Bonds by Bond Rating (1981-2013)*
1 2 3 4 5 6 7
BB 0.57% 1.76% 2.93% 3.69% 4.63% 5.68% 6.73%
B 3.30% 8.26% 12.28% 14.81% 16.62% 17.81% 18.26%
CCC/C 31.76% 38.10% 40.01% 41.16% 42.84% 42.84% 44.96%
*from: “Default, Transition, and Recovery: 2013 Annual Global Corporate Default Study and Rating Transitions”, Standard & Poors Ratings Direct, March 19, 2014.
17
Conclusions• 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: $150 billion• Default Statistics Within 5 Years of Original Transaction Date
• 11.2% of Individual LBOs Defaulted• 12.1% (13.6% ,including exits) of the Number of LBO Loan Issues Defaulted• 11.5% (12.9%, including exits) of all LBOs defaulted by Implied Bond Ratings• 20.1% (21.2% , including exits) of all LBOs defaulted by Loan Dollar Amount
• Private Equity Sponsored LBOs had Significantly Lower Cumulative Mortality (Default) Rates than did Comparably Rated Corporate Bonds over the Last Two Decades
• Similar Results for Default Losses
18
Remarks
• Possible Positive Reasons for Lower Default Rates, and Losses, on PE-Sponsored LBOs compared to Comparably Rated Corporate Bonds:
• Greater Access to Capital by PE-Sponsored LBOs• Greater Funds to Support Ailing Companies• Better Portfolio Management and Management Support Techniques than
Stand-Alone Companies• Better and Cheaper Access to Traditional and “Shadow Banking” Funds• LBO Management More Heavily Invested in Success; More “Skin in the Game”• Private Firm versus Public Firm Flexibility• Rating Agency Bias in Rating LBOs?
• Possible Negative Reasons for Higher Default Rates and Losses:• Asset Stripping (Crown Jewels) to Repay Debt (Could Work Both Ways)• Subsequent Debt Issuance to Pay-out Dividends to Owners• Rating Agency Bias in Rating LBOs?
19
CURRENT LBO AND DEFAULT STATISTICS
Straight Bonds Only Excluding Defaulted Issues From Par Value Outstanding, (US$ millions), 1971 – 2015 (10/15))
Historical H.Y. Bond Default Rates
20
Year
Par Value Outstandinga
($)
Par Value Defaults
($)
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 58,088 992 1.708
1984 40,939 344 0.840
1983 27,492 301 1.095
1982 18,109 577 3.186
1981 17,115 27 0.158
1980 14,935 224 1.500
1979 10,356 20 0.193
1978 8,946 119 1.330
1977 8,157 381 4.671
1976 7,735 30 0.388
1975 7,471 204 2.731
1974 10,894 123 1.129
1973 7,824 49 0.626
1972 6,928 193 2.786
1971 6,602 82 1.242
Standard Deviation
(%)
Arithmetic Average Default Rate (%)
1971 to 2014 3.117 3.097
1978 to 2014 3.340 3.273
1985 to 2014 3.843 3.416
Weighted Average Default Rate (%)*
1971 to 2014 3.491
1978 to 2014 3.496
1985 to 2014 3.513
Median Annual Default Rate (%)
1971 to 2014 1.664
Source: Author’s compilation and Citigroup/Credit Suisse estimates
2015 (10/15) 1,595,839 35,414 2.219
Quarterly Default Rate and Four-Quarter Moving Average
1989 – 2015 (3Q - Preliminary)
Source: Author’s Compilations
Default Rates on High-Yield Bonds
21
Historical Default Rates and Recession Periods in the U.S.
22
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))
23Source: S&P Capital IQ LCD
Purchase Price Multiple excluding Fees for LBO Transactions
Purchase Price Multiples
8.4
6.7
5.2
6.3
7.07.4
8.3 8.1
9.9
8.8 8.8 8.98.5
9.0
9.8
11.6
6.26.7
9.710.1
7.5
9.7
8.88.7
8.27.8
8.79.1
8.1
7.46.9 6.7 6.8
7.3
8.0
0x
2x
4x
6x
8x
10x
12x
14x
1998(90)
1999(133)
2000(116)
2001(51)
2002(40)
2003(66)
2004(127)
2005(134)
2006(178)
2007(207)
2008(69)
2009(23)
2010(78)
2011(87)
2012(97)
2013(95)
2014(136)
1Q-3Q15(101)
3Q15(35)
Public-to-Private All Other
N/A
(# obs.)
N/A
24
Average Total Debt Leverage Ratio for LBO’s: Europe and US with EBITDA of €/$50M or More
Source: S&P Capital IQ LCD
4.44.5
4.8
5.55.8
6.6
5.3
4.54.6
4.8
4.5
4.9
5.35.0
4.1
4.74.9
5.4 5.5
6.2
4.9
4.0
4.7
5.2 5.35.4
5.85.7
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
7.0x
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Jan-Sep 15
Europe US
25
Maturity Profile of Leveraged Debt – As of 12/31/14
Source: S&P Capital IQ LCD
2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 20250
50
100
150
200
250
18
35
72
106
156
184
200
171
84
58
131
22
59
98
155
228 228
19
0 0 0
Bonds Institutional Loans
$ (B
illio
ns)