Levered loan defaults could top 10% after Toys R Us filing

Fitch Ratings said Sears, another distressed retailer, could make that number 12 percent if it seeks court protection by the end of the year.

Toys R Us has followed a number of other retailers – many private equity-backed – into bankruptcy, which could push the default rate on institutional levered loans above 10 percent by the end of the year, a new report from Fitch Ratings showed.

The Wayne, New Jersey-based company, which filed its Chapter 11 petition on Tuesday with $5.27 billion, has already pushed that number to over 7 percent, up from August’s 5.3 percent. As Private Debt Investor recently reported, distressed investors are in on the debtor-in-possession financing, including Angelo, Gordon; HPS Investment Partners; and Redwood Capital Management.

Over the past 12 months, 76 percent of the defaults in retail have been triggered by a bankruptcy filing rather than a distressed-debt exchange or a missed interest payment, Fitch Ratings leveraged finance analyst Eric Rosenthal told PDI.

Another retailer facing less-than-stellar prospects, Sears, faces $1.4 billion in debt maturities next year, and if the company also seeks court protection, the institutional levered loan default rate could reach 12 percent. Sears will need $1.5 billion-$1.75 billion of annual liquidity, with projected EBITDA of negative $600 million-$800 million.

Markets are bearish on the sector’s distressed names – the median price on broadly syndicated term loans in the sector 30 days after a default is 40 cents on the dollar, the lowest among all sectors, Rosenthal said. The equivalent number for the energy sector is 80 cents on the dollar.

Toys R Us sought court protection because of a highly-levered capital structure – with annual cash debt servicing cost of $400 million – as well as the costs of above-market leases and increasing competition from big-box retailers and online shopping.

A number of private equity-backed retailers have sought court protection recently, including Gymboree Corporation, which Bain acquired in 2010 for $1.8 billion, and Payless Shoes, which Golden Gate Capital and Blum Capital Partners acquired in $1.32 billion deal in 2012.