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)