3 JUNE 4, 2012 SPECIAL COMMENT: LEVERAGED BUYOUTS LESSONS FROM 200 LBO DEFAULTS
LBO recoveries perform through default cycles
A look at the last three default cycles further demonstrates that LBOs do not exhibit unusual recovery characteristics. The bar chart (Fig. 2) shows the three separate cycles in which default rates haveexceeded the historical average. During the three default cycles, average family recoveries were similarfor both LBOs and non-LBO companies, mostly in the low-50% range, further support for the view that LBOs are not inherently disadvantaged in terms of recoveries. In most cases, average family recoveries were slightly lower for LBOs; the one time that was not the case was in the 1999-2004default cycle, in which non-LBO defaults had lower average family recoveries because they includedsome large telecommunications startups that had very poor recoveries.
Number of Defaults by Year
0204060801001201987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011Non-LBO LBO
Source: Moody’s Ultimate Recovery Database
Choice of default type is a key driver of LBO recoveries
One way that LBOs have achieved this relative parity of recoveries with non-LBOs is through the highproportion of distressed exchanges and prepackaged bankruptcies among defaulting LBOs. As shownin Fig. 3 on the following page, less than half of LBO defaults were regular bankruptcies (notprepackaged), relative to the nearly two thirds of non-LBOs that defaulted via bankruptcy. For seniorcreditors, a prepackaged bankruptcy or distressed exchange typically yields higher recovery rates thandoes regular bankruptcy because only the junior debt typically suffers losses. This is the case becausecompanies experiencing distressed exchanges and prepackaged bankruptcies are usually less distressed, with higher enterprise values, than companies experiencing regular bankruptcies. Further, distressedexchanges are a common way that equity sponsors will initiate a default so as to maximize theownership position they retain in the sponsored company.There are a few more things to note about distressed exchanges. First, distressed exchanges may befollowed by additional distressed exchanges or an eventual bankruptcy filing if the company remainsunder credit stress. Second, our database captures each of these instances of default and counts itseparately. Finally, for purposes of this analysis, our family recovery calculations for distressedexchanges included an allocation of full recovery
for the debt instruments that did not default.Therefore, family recovery rates were typically high in the distressed exchanges, even as the defaulteddebt that was subject to the exchange incurred larger losses.