Privately Funded Companies Dominate Shallow Trash Depths
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The number of companies with the lowest credit scores surpassed the peak of the 2008 financial crisis, as dozens of companies with heavy debt loads were downgraded.
Many companies with downgraded ratings are owned by private equity firms, such as the KKR-backed medical staffing company. To consider, a beauty company backed by TPG Capital Anastasia beverly hills and Party town, a retailer until recently backed by Thomas H Lee. The trio joined a long list of companies whose debt was tied up by Moody’s last month as efforts to reduce the spread of Covid-19 reduced cash flow.
The total number of companies in the bottom five ranks of the agency’s credit ratings ladder, as well as those at risk of being downgraded from the top echelon, increased from 213 to 412, marking an increase of over 40% from the depths of the last financial crisis.
Two-thirds of those firms in the lower brackets of the solvency spectrum – 273 – are backed by private equity groups, suggesting Wall Street traders have burdened borrowers with more debt than they do. can withstand it.
The rush to downgrade is seen as a harbinger of tensions to come, as a growing number of companies are expected to be unable to service their debts as the crisis worsens.
“We fully expect an increase in defaults,” said Chris Padgett, head of leveraged finance at Moody’s, who added that the extent of the credit deterioration depended on the length of the economic shutdown and social. “We’re still in the middle of this. . . we could easily see a default rate similar to the financial crisis.
A 21-point Moody’s scale descends from a high point of Aaa to a low point of C, typically assigned to companies in default with little prospect of recovery of principal or interest.
There are several notches for each intermediate rating band, and companies are considered to be below the investment grade – or “subject to substantial credit risk” – when they reach Ba1, 11 steps down. Default is seen as a more imminent risk once borrowers slide to Caa1, five from the bottom.
Ms Padgett noted that the debt markets have entered the current downturn in an already worse state than in previous cycles, with a growing number of lower-rated issuers following a series of buybacks that left them borrowers with significant debt relative to their operating profits.
She added that while some businesses in industries such as retail and hospitality were particularly vulnerable due to the nature of social distancing, other businesses were at risk simply because they were the product of takeovers. also aggressive leverage.
“They didn’t necessarily have to be in the eye of the storm, but they didn’t have the right track record before the crisis,” she said.
The downgrades could cause problems for investors exposed to vehicles known as secured loan bonds, which bundle riskier corporate debt to hedge payments on new bonds with varying exposure to default from under-issuers. underlying.
These vehicles were the source of the expansion of credit for PE-backed buyouts in the leveraged loan market, which exploded to around $ 1.2 billion in assets as private income investors were happy to take more risk.
CLOs typically have triggers on the amount of lowest-rated loans they can hold before repayments are diverted from investors in the riskier tranches of the CLO to repay investors higher in the pecking order.
“The creditworthiness of the borrower is deteriorating before our eyes,” said Christopher Acito, Managing Director of Gapstow Capital Partners. “This is a very important issue for the CLOs.