Defaults of private loans fell again in the fourth quarter, to less than half the rate at the 2020 peak in the second quarter as the COVID-19 pandemic unfolded, according to an index published today.
Private credit defaults declined to 3.6% in the fourth quarter of 2020, from 8.1% in the second quarter and 4.2% in the third quarter, the Proskauer Private Credit Default Index showed.
The Proskauer Private Credit Default Index includes 689 active loans in the United States representing $129.3 billion in original principal amount, across all major industry groups.
The quarterly index comprises U.S. dollar-denominated senior secured and unitranche loans to U.S. companies generating EBITDA of zero to $1 billion for which the law firm has closed credit documents. Proskauer does not release the underlying data.
The fourth quarter default rate was the lowest level since the index’s creation. The quarterly default rate of the index was first published in the first quarter of 2020. The law firm has tracked some 200 data points on deals that it closes, and began tracking defaults in 2019.
Once again, larger companies in Proskauer's index fared better than smaller ones. The default rate for loans to borrowers generating $50 million of EBITDA or greater at origination fell to 2.6% in the fourth quarter, from 2.8% in the third quarter and 5.3% in the second quarter.
This compares to a default rate of 2.9% for borrower companies generating $25 million to $49.9 million of EBITDA, which was down from a peak of 6.7% in the second quarter.
Liquidity, chase for deals
“It’s a reflection of the strength of our economy in general, and of the middle market economy. It also shows the success that company management, private equity sponsors and private credit lenders have had in managing difficult times,” said Peter Antoszyk, co-head of the Private Credit Restructuring Group at Proskauer.
The pandemic has been the first major test of how private credit lenders would perform in an economic downturn since the private credit industry came into existence 15-20 years ago, said Antoszyk.
“Private credit lenders have proved their mettle. They have the tools in their toolbox to deal with it. They anticipated it — not necessarily a pandemic, but a downturn, by building up teams with restructuring expertise,” Antoszyk said.
One key reason for the decline in the default rate is the volume of liquidity in the market. Global private equity and venture capital dry powder is at a record level approaching $2 trillion, Preqin reported. Capital raising for funds with direct lending strategies was more than 60% higher in January 2021 compared to a year earlier.
“All this liquidity is going to help soften the blow, tamp down some of the hard restructuring activity, such as bankruptcy filings. Restructuring with a private credit lender is very different. They have the flexibility to deploy capital up and down the balance sheet in support of a company. And they can take over a company if they need to, although it’s not their first choice,” said Antoszyk.
Strong market conditions have led to intense competition for deals.
“Lenders are continuing to work with their borrowers to provide the liquidity and flexibility that they need to navigate through these uncertain times,” said Stephen Boyko, co-chair of Proskauer’s Private Credit Group. “The market for new financings remains strong, and we have seen fierce competition for all sizes and types of loans,” said Boyko.
Despite the reprieve offered by receptive market conditions, there is likely to be more pain ahead.
“We’re not out of the woods yet. We’re going to see some situations in which the can was kicked down the road come back in 2021 and early 2022. This recovery is going to have a long tail. We don’t know how COVID-19 is going to play out,” said Antoszyk.
“It will still be an issue who can ride out the pandemic. Liquidity remains a concern. There will be a steady drip of restructurings,” said Antoszyk.
Defaults in Proskauer's index are defined as loans that have a payment, financial covenant or bankruptcy default. They are defaults expected to last over 30 days, meaning "technical" defaults that are remedied quickly are excluded.
The default rate is calculated by dividing the number of defaulted loans by the aggregate number of loans in the index.
Default is assumed at the earliest of a missed debt payment, a distressed restructuring, a bankruptcy filing, a financial covenant breach or a loan modification in anticipation of default.
Defaults include credit agreements that were amended in anticipation of a default. A loan can be reclassified as non-default, such as when a borrower restructures debt and becomes current on loan payments, according to Proskauer's methodology.