Why private equity didn't create a second credit crunch.
FORTUNE – A major financial worry coming out of the recession was a looming "wall" of high-yield bond maturities, largely related to a glut of leveraged buyout transactions completed in 2005 and 2006. Could all of that debt be repaid on time and, if not, would America experience a wave of corporate bankruptcies that would both decrease credit availability and increase unemployment?
So far, however, the maturity wall has proven to be little more than a mossy speed-bump. In fact, corporate default rates have actually been on a consistent decline since peaking in 2009.
Jason Thomas and Linda Pace, The Carlyle Group's head of research and head of U.S. structured credit, respectively, today released a paper that seeks to explain why the predictions were so wrong.
Their primary conclusion is that the concentration of loan maturities in a certain time period does independently generate increased risks of default. Instead, the key factors are macro-economic and credit quality.
"The gloom and doom predictions were based, in part, on a notion that the sheer volume of claims was going to be a source of stress independent of the state of the economy," Thomas explains. "This was simply incorrect."
Equally important was that the markets quickly found a way to handle some of the upcoming maturities that threatened to become problematic. Tactics like "amend-and-extend," through which loan maturities were extended in exchange for increasing interest rates or making other lender-friendly changes. There also were plenty of traditional refinancing through the bond markets -- particularly as the price leveraged loan prices fell below that of competing asset classes and buyers began to recognize arbitrage opportunities.
"The impact of capacity constraints should therefore be transitory and last only as long as it takes investors to recognize and capitalize on the investment opportunity," the researchers wrote.
In terms of credit quality, the researchers argue that some fears were prompted by false equivalency between subprime mortgages and bubble-era buyouts. One difference was that each syndicated corporate loan gets an individual credit rating, while subprime loans were bundled by the hundreds (or thousands) without examination of each underlying borrower. Second, leveraged loans typically require the lead banker to maintain at least some of the loan on its own balance sheet, whereas mortgage originators could sell before the deeds were dry. Finally, CLOs often included performance fees designed to discourage low-quality loans from being included in the pools.
None of this is to suggest that private equity firms shouldn't worry about taking out bad loans on portfolio companies, because the invisible hand will solve all. Instead, it's simply to explain that leveraged loan maturities aren't like piranha: Volume doesn't increase carnage.
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