Defaults among sponsored companies can vary, Moody's Investors Service says in a new report. For highly rated companies, the risk of default can increase due to a leveraged buyout, but for companies rated in the Caa and below range, the sponsor can actually take on the "white knight" role and help keep the company from defaulting. The number of defaults also varies across financial sponsor; the report, however, does not name which sponsor owns the most companies that have defaulted and Kenneth Emery, senior credit officer and an author of the report, declined to name them.
In the special comment, "Default and Migration Rates for Private Equity-Sponsored Issuers," Moody's focused on speculative-grade issuers where a majority of capital invested is from equity sponsors. It looked at the "sponsor-designated field" in Loan Pricing Corp.'s DealScan database to identify whether a loan is sponsored or not sponsored and then matched those loans with Moody's rated issuers to create the overall dataset.
The ratings agency looked at 2,972 North American nonfinancial speculative grade companies from 1987-2005. Of the 2,972 total issuers in the sample, 1,940 (65%) were designated as non-sponsored issuers, 582 (20%) became sponsored at some point in time upon entering the sample and 450 (15%) were always sponsored. Industrials represented 35% of all issuers by industry and within the industrial category, 40% are owned by sponsors. Consumer companies only represent 9% of issuers across industries, but 50% of consumer companies are owned by sponsors.
The ratings agency shows that on average, sponsored issuers tend to be lower rated than non-sponsored issuers; over 65% of sponsored firms are rated single. Non-sponsored issuers are also more than twice as likely to be rated Ba, as compared to sponsored issuers.
"The impact on an issuer's creditworthiness of being acquired by a private equity sponsor varies with the issuer's rating just prior to being acquired," the report says. It explains that issuers rated Ba prior to being bought out experience twice the default risk as similarly rated issuers. It says that issuers rated B before being acquired have about a 75% higher default risk than other B-rated issuers. It looked at 12 companies rated Caa-C before being acquired and those have a much lower risk of default than similarly rated companies that are not sponsored, suggesting the "white knight" role mentioned above. Moody's only looked at 12 because of the small number of issuers that fit the criteria of being rated Caa-C and are sponsored.
These numbers, however, may change if the massive number of leveraged buyouts from 2006 is added to the mix. "Historical default rates in the results may not be entirely indicative of future default rates given some of the recent changes we have seen in the private equity market," Emery said.