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Fitch warns of 'double defaults'

Many of the European companies that have already defaulted on leveraged loans may do so again, the ratings agency warns – although there are signs of progress in certain industries.

A fresh wave of leveraged loan defaults may be imminent but this time, recovery rates will be lower and losses more substantial, according to Fitch Ratings.

The ratings agency believes that more than half of the companies that have defaulted on leveraged loans in the last few years are likely to default again. Companies that continue to rest on sub-performing business models, struggle with operating costs or remain hard-pressed by heavy debt burdens are most at risk of hitting a refinancing wall, it added. 

“There is a split between the B* and higher rated credit opinions in our portfolio, which are more likely to find a refinancing solution to their approaching debt maturity, and the B-* and below, which are weaker credits that face a lot of competition to refinance their debt,” Cecile Durand-Agbo, a director in Fitch Ratings' European Leveraged Finance group, told Private Equity International

This is mainly because lenders did not take sufficient write-offs the first time around, said Philip Hertz, joint head of restructuring at Clifford Chance.“A number of financial institutions which [were] not willing to take any impairment as a result of a capital restructuring have been kicking the can down the road in the hope it can be avoided”. 

A number of financial institutions which [were] not willing to take any impairment as a result of a capital restructuring have been kicking the can down the road in the hope it can be avoided.

Philip Hertz

The restructurings of 2009 and 2010 typically involved covenant waivers and some sort of cash injection but there was often no major capital restructuring or attempt to decrease the interest burden, Fitch says.

But while banks have so far done all they can to avoid booking losses, they are now adopting a much more realistic view, according to David Ford, director of credit fund management at Intermediate Capital Group. This will probably push them to concentrate losses on the next round of restructurings, he said. 

A second round of defaults, which Fitch expects could happen within the next couple of years, is likely to lead to much larger write-offs. 

Private equity firms will undoubtedly be affected, Durand-Agbo said, particularly at the smaller end of the market. Whilst fund managers with assets over a certain size may be able to tap the high-yield bond market, sell the companies or amend debt maturities to buy time, mid-cap firms will have no choice but to restructure.

However, Ford argued that there would not be too many nasty surprises. “I don’t think there is anything new coming out of the woodwork. It’s the same names that get talked about.” He thinks that less than 25 percent of the leveraged loan market will be affected, and that most private equity firms have already made contingency plans to deal with their troubled assets. 

The landing might be softer than expected for some traditionally cyclical sectors, such as industrials or chemicals, he added. “These businesses came out of the last crisis in pretty lean, good shape, so they’re doing OK from a cash generation perspective,” Ford said. “And global demand is in a much better place than it was in 2009”. 

Directories, print media and retail may be the most exposed industries, he suggested, as they continue to wrestle with structural challenges.