JPMorgan does an about-face on corporate default rates

Clearly 2009 has produced a record for high yield bonds and leveraged loan defaults. But the debate had centered around the state of the over-leveraged US corporations (mostly the products of LBOs) in 2010. JPMorgan's change in default rate forecast for 2010 for non-investment grade companies is astounding.

Default forecast on March-2, 2009:



Default forecast on October-1, 2009:



What drove them to change their view so drastically? It was actually two trends that dominated the non-investment grade corporate markets this year.

1. The opening of the primary HY bond market allowed firms to issue new bonds to refinance their existing debt, particularly their loans. The chart below shows that the bulk of new issues were to refinance debt instead of for expansion or acquisitions.


source: JPMorgan


2. "Amend and extend" allowed stressed firms to avoid bankruptcy by rolling their existing loans into longer maturities.

Some of this of course is just "kicking the can down the road", but it makes for a less tumultuous 2010.

Pushing out the wall of leveraged loan maturities

"Amend and Extend" has been in full swing in the corporate leveraged loan space. Pushing the day of reconing further out in hopes of finding a way to deleverage before maturity has been the theme for many leveraged firms. A total of $38 billion of institutional loans have gone through the amend and extend process.


source: LPC


Lenders have the same dreams and hopes as the borrowers - let's give the company more time and hope earnings will improve enough to blow the loan out. The fact that there is practically no new loans in the pipeline keeps the loan market strong and helps the "amend and extend" process as well. The chart below shows how the bond market has replaced institutional loan issuance, capping the loan market size.


source: LPC

"Amend and extend" saves the day for many leveraged companies

A couple of months back we discussed the dilemma facing LBO financed companies(Leveraged loans - a race against time) as the leveraged debt maturities loom. Many firms have been trying to issue bonds to refinance their term loans. But a new approach is taking hold as investor demand for leveraged loans continues to be strong. It's called "amend and extend". The idea is that the loan remains in place, while the lenders permit a maturity extension in return for better terms. The new terms may include higher spread, better covenants, and a reduced notional. From Thomson Reuters:

So far this year, approximately $28.9 billion in amend and extend issuance has been completed with another roughly $1.8 billion in process. Just this week it was learned West Corp. is in market to push out the maturity on $750 million of its $2.3 billion term loan from 2013 to 2016. In return, extending lenders will get a 125 bps price bump to LIB+362.5.

Here is an example (from PRNewswire)

SANDUSKY, Ohio, Aug. 6 /PRNewswire-FirstCall/ -- Cedar Fair Entertainment Company (NYSE: FUN), a leader in regional amusement parks, water parks and active entertainment, today announced that it has received consent from its lenders to amend its credit agreement. It also announced that lenders holding $900 million of its term debt will extend the maturity date of their commitments by two years. The extended term debt will mature in 2014 and bears a rate of LIBOR plus 4.0%.

The chart below shows the recent "amend and extend" transactions and the corresponding spread increases.

This strategy buys leveraged companies time to try to de-leverage by improving their earnings or cutting costs. "Amend and extend" process is the reason we may not see the levels of defaults many have been forecasting, such as the JPMorgan/S&P projections below.