Newsmakers : Private Equity Investments Linked To Corporate Defaults

Vazza: Expects the default rate to continue growing.

As private equity investors size up the new opportunities the credit crunch presents, companies in their sights might do well to consider a report published by Standard & Poor’s in September. As well as noting that global corporate defaults have risen sharply in the first eight months of 2008, it shows that more than two-thirds of the companies that have defaulted this year were involved in transactions involving private equity.

While far from proving that private equity ownership or involvement in a company increases the risk of default, the report reinforces long-voiced complaints from the corporate sector—and also from labor unions—that the private equity investor is inherently focused on the short-term. Moreover, it appears to give weight to criticisms that much of the success of private equity firms has been dependent on easily available cheap debt; now that debt has dried up, times have become tougher.

In the first eight months of 2008, 55 entities defaulted globally, compared with just 22 in all of 2007 and 30 in 2006, according to the report, provocatively titled “Default Autopsy Finds Traces Of Private Equity DNA.” The global speculative-grade default rate has increased to 1.9%—more than double the year-end 2007 level of 0.86%.

In the United States, which accounts for 53 of the 55 defaults, the default rate increased for eight consecutive months to 2.5% in August, from a 25-year low of 0.97% at the end of 2007. “We expect the default rate to continue this ascent and reach 4.9% in the next 12 months,” says Diane Vazza, head of S&P;’s global fixed-income research group.

Of the 55 defaults, nearly 70% were involved in transactions involving private equity at one point or another, which may or may not have facilitated the default, according to Vazza. S&P; expects to see private equity involvement in the majority of the corporate defaults over the next 12 to 18 months—primarily because of the pervasiveness of the firms’ investments. As Vazza notes, “Strategies and financing adopted by private equity sponsors are not always to the detriment of ailing companies, and [their involvement] may have already deferred or even averted defaults.”