LBO Defaults to Climb as Debt Costs Top Growth, Mudrick Says
Defaults on speculative-grade debt will climb in the next five years as companies bought by private-equity firms before markets seized up in 2008 struggle to boost earnings, said hedge-fund manager Jason Mudrick.
Borrowers may renege on $150 billion to $250 billion of leveraged loans and high-yield bonds due by 2015, or between 15 percent and 25 percent of the amount maturing, said Mudrick, president of Mudrick Capital Management LP, at a briefing in New York.
The former money manager at Contrarian Capital Management LLC, who started his fund in July 2009 and oversees $150 million, is predicting the rise in defaults even as Moody’s Investors Service said the 12-month rate in the U.S. fell to 3.5 percent in November from 14.7 percent last year. Moody’s is projecting the measure will drop to 2.1 percent a year from now as the economy grows and after borrowers sold a record amount of bonds this year that helped push out maturities.
“Don’t believe the hype,” said Mudrick, 35, from his Midtown Manhattan office. “There are still a lot of defaults to come.”
The fund has gained 10.5 percent this year and 27 percent since it started, after deducting fees, according to a person familiar with the returns, who declined to be identified because the information is private. Hedge funds that buy distressed debt returned 8.3 percent on average this year, according to Hedge Fund Research Inc. in Chicago.
Maturing Debt
While private-equity backed companies have been able to trim debt and refinance near-term borrowings, they’ve yet to address the bulk of the credit that needs repaying, which will peak in 2013 and 2014, Mudrick said. Companies that were acquired in leveraged buyouts in the years leading up to the crisis have to repay $421 billion of the $968 billion of maturing debt through 2015, he said.
Earnings aren’t likely to grow fast enough to support the yields investors would demand to refinance borrowings for such debt-laden firms, Mudrick said. Many companies have borrowings that are more than 10 times their earnings before interest, taxes, depreciation and amortization costs, or Ebitda.
“The problem is just too much leverage in a slow economy,” said Mudrick. “Anybody levered more than seven times when it comes time to deal with this, it’s going to be tough.”
Companies acquired in $1.17 trillion of leveraged buyouts completed from 2006 to 2008 had debt that was between 7.2 times and 8.2 times Ebitda on average in the years they were acquired, according to data compiled by Mudrick. Assuming a 30-percent drop in Ebitda since then, the ratio has climbed to between 10.3 times and 11.7 times, he said.
U.S. companies have sold a record $273.5 billion of high- yield, high-risk bonds this year, according to data compiled by Bloomberg.
Average yields on the debt, ranked below Baa3 by Moody’s and less than BBB- by Standard & Poor’s, fell to 7.9 percent from 9.2 percent during the same period, Bank of America Merrill Lynch index data show. Leveraged loan prices, meanwhile, have climbed 4.28 cents to 91.96 cents on the dollar, according to the S&P/LSTA US Leveraged Loan 100 Index.
To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net;
To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net
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