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Companies backed by private equity will face the same or higher default rates in the year ahead, says survey

At a time when private-equity firms are sitting on as much as USD500 billion waiting to be invested, some 74% of senior restructuring professionals expect that private equity-backed companies will face the same or higher default rates than will publicly-traded companies in the next 12 months, with 61% seeing higher default rates. That’s according to a survey of 80 US bankruptcy lawyers, investment bankers, fund managers and restructuring professionals released today by AlixPartners, the global business-advisory firm.

“It seems like everyone these days is talking about the half-trillion dollars in ‘dry powder’ that private equity is sitting on, and how that money will have to be put to use fairly soon,” says Peter Fitzsimmons, president of North America at AlixPartners and co-head of the firm’s Turnaround and Restructuring Services practice. “But, as this survey suggests, private equity firms should continue to be selective about how they deploy new or additional capital, and many would benefit from designing specific programs for monitoring the use of funds when new or additional investments are made.”

AlixPartners’ survey was conducted to gauge the expectations of top restructuring experts on a host of issues affecting large- and middle-market companies and alternative-investment firms, including economic trends, bankruptcy trends and government policies.

When asked which industries are most likely to face distress in the year ahead, 24% said retail, 18% said restaurants/food service and 12% said commercial real estate. Packaging, healthcare, energy, consumer products and financial services also received votes.

As the debate on the federal debt ceiling rages on Capitol Hill, most of the experts surveyed said they expect to see a downgrade of U.S. Treasury debt if the ceiling is not raised. A decisive majority (86% of those surveyed) said this would have a negative impact on the economy. At the same time, 88% of those polled said they expect interest rates will rise at the conclusion of the U.S. Federal Reserve’s second round of quantitative easing, also known as QE2, set to expire at the end of this month.

Despite the widespread and highly publicised discussion over the past year about municipal debt defaults, the experts have a more positive outlook on municipal debt, with only 45% expecting a major US municipal default in the coming year, versus 90% in last year’s AlixPartners survey. As expected, most do not expect to see movement anytime soon on legislation allowing US states to file for bankruptcy.

“This doesn’t mean that there will not be major municipal debt problems – cities all over the U.S. are facing a lot of debt and are running out of options,” says Fitzsimmons. “Many are in a situation where things can still be turned around, but it is going to take some serious restructuring.”

In light of the very challenging recent economic crises in Greece, Portugal and Ireland, a majority (61%) of those polled said that over the next year Western Europe is most likely to house the best opportunities for distressed investing. Not surprisingly, 51% of experts surveyed said Western Europe would be the global region most likely to see business restructurings in the year ahead, with 14% citing the United States.

This year’s survey also showed that 97% of restructuring experts believe that pre-packaged, pre-arranged and other accelerated bankruptcies are now a “permanent” part of the restructuring landscape. In addition, 67% believe that at least half of all bankruptcy filings in the U.S. over the next 12 months will be of this variety.

Given the desire for brevity, there also seems to be a growing demand for more and better up-front planning in the bankruptcy and restructuring processes. When asked to name the most important element of any successful restructuring, 34% cited good coordination among a company’s legal and financial advisors, which was second only to a company’s new capital structure, at 37%.

“It’s déjà vu all over again for distressed investors and owners, and for many American companies,” says Lisa Donahue, managing director at AlixPartners and co-head of the Turnaround and Restructuring Services practice. “All the old ‘amend-and-extend’ debt-maturity practices that everyone supposedly swore off during the financial crisis – covenant-lite, PIK-toggle, dividend recap, etc. – are all back with a vengeance. And now it appears that ‘quick-rinse’ bankruptcies might be here to stay, too. However, are companies really being fixed, or are we just kicking the can down the road?

“More companies, including those owned by private-equity firms, need to improve their operational performance and their liquidity,” Donahue added. “Today, many companies are living on time borrowed from the U.S. government when it pumped so much money into banks and the economy during the financial crisis. But when that borrowed time runs out, those with weak balance sheets are going to be caught short. That’s why now is the time for fixing, not just extending.”

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