Corporate defaults: The LBO zombies set to stalk the market
A wave of corporate defaults will follow the onset of a vicious global recession as sure as night follows day. But this time, that night will see zombie companies stagger the earth, dragging their uncovenanted leverage multiples behind them. Louise Bowman explains.
Blight of the living dead:
SPEAKING AT A Loan Market Association (LMA) conference in October, Ian Cash, head of Alchemy Partners’ £300 million ($509 million) Special Opportunities Fund, drew an alarmed gasp from an already rather anxious audience by revealing that his five-year expectation is for default rates in the European high yield market to rise to an eye-watering 50%. This prediction is doubly startling considering the figures involved. According to Fitch Ratings, €145 billion B-rated corporate debt is due to refinance in Europe by 2016, €86 billion of which is highly leveraged, pre-crunch LBO debt. In the US, $1.7 trillion high-yield loans were written in 2006 and 2007 alone. Clearly, if default rates range as high as Cash is suggesting, this could become a very big problem indeed. Recovery rates are likely to be much, much lower than historical experience as well.
Headline-grabbing as default predictions such as this are, they conceal the fact that, in this downturn, even some corporates that don’t default could be as much of a concern as those that do. Those companies become zombie companies – firms that are underperforming but refuse to die because the lax documentation that crept into the lending market in the boom years acts as a life support machine to a terminally-ill patient.