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U.S. Leveraged Loan Funds Lose $377M in Largest Outflow Since June 2016

U.S. loan funds recorded an outflow of $377 million for the week ended Aug. 23, according to Lipper weekly reporters only. This exit marks the largest outflow from the asset class since the week ended June 29, 2016, when the outflow was $525 million.

U.S. Loan Fund Flows Updated

Mutual funds made up $295 million of the total outflow this week, as $82 million exited ETFs.

The year-to-date total inflow is now $14 billion, based on inflows of roughly $9.7 billion to mutual funds and $4.4 billion to ETFs, according to Lipper.

The four-week trailing average dipped into negative territory for the first time since the week ended July 12, falling to negative $109 million, from positive $9 million last week.

The change due to market conditions was negative $115 million, marking the third straight week of decreases. Total assets were $96.8 billion at the end of the observation period. ETFs represent about 19.5% of the total, at $18.9 billion. — James Passeri

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US Leveraged Loan Returns Down 0.09% MTD; +2.53% YTD

Loans gained 0.01% today after remaining unchanged yesterday, according to the S&P/LSTA Leveraged Loan Index.

The S&P/LSTA US Leveraged Loan 100, which tracks the 100 largest loans in the broader Index, gained 0.01% today.

Loan returns are –0.09% in the month to date and 2.53% in the YTD.

Daily loan index 2017-08-23

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Bankruptcy: Avaya Cuts Deal with Credit Panel as Proposed Plan Faces Flak

Avaya said that it has reached an agreement with the unsecured creditors’ committee in its Chapter 11 case under which the cash distribution to unsecured creditors was increased to $60 million, from $25 million, with an election for holders of unsecured claims to choose to receive their recoveries in the form of reorganized stock.

The agreement also eliminated the 8.2% recovery cap for unsecured creditors, the company said in a statement filed today with the Manhattan bankruptcy court.

The settlement is subject to documentation, and the company said it would file a revised reorganization plan and disclosure statement prior to a hearing on the disclosure statement, currently set for Aug. 25.

The agreement comes on the heels of several objections filed to the company’s proposed disclosure statement by key creditor groups in the case.

Avaya announced on Aug. 7 that it had entered into a plan support agreement with first-lien lenders, and a separate agreement with the Pension Benefit Guaranty Corp., on a settlement to drive a reorganization plan. And while the company also filed a proposed amended plan that day, it also said that it would “continue to work to build consensus and gain the support of other stakeholders.”

In an objection filed last week, the ad hoc committee of second-lien lenders in the case charged that the company’s proposed amended reorganization plan was the result of “backroom negotiations” that, “contrary to the debtors’ stated desire for a prompt emergence from Chapter 11, … will only lead to protracted and costly litigation.”

According to the ad hoc panel, the company’s proposed plan, based on an agreement the company said it reached with more than 50% of its first-lien lenders, represents a strategy to pursue a cram-down “dictated by the ad hoc first-lien group, as opposed to the negotiated, arms-length process with all of their creditors that they [had previously] represented to the [bankruptcy] court.”

The second-lien group, alleging that it was excluded from negotiations that resulted in releases being granted to the company’s managers, officers, and directors in connection with intercompany and intra-company disputes affecting the their interests, and alleging conflicts of interest and self-dealing in connection with the settlements underlying the company’s proposed reorganization plan, argued that the proposed reorganization plan was “patently unconfirmable on its face.”

Similarly, the ad hoc crossover group of creditors holding first-lien, second-lien, and unsecured debt in the company, also said that the disclosure statement was premised on a “patently unconfirmable” plan.

Both ad hoc creditor groups argued that it would pointless to approve the disclosure statement and conduct a voting process for a reorganization plan that does not meet legal requirements for confirmation.

A third objection, filed by one of the company’s creditors, SAE Power Co., argued that the disclosure statement failed to disclose the existence of hundreds of millions of dollars of unsecured claims, primarily litigation claims, and numerous administrative claims, that “the company may well have no ability to satisfy.”

As a result, SAE argued, the proposed recovery for unsecured creditors (at the time, $25 million) could be “greatly diminish[ed].”

It is unclear whether the company’s agreement with the unsecured creditor panel fully addresses SAE’s concerns.

As reported, the ad hoc group of second-lien lenders presented an alternative reorganization proposal to the company last month, but Avaya has, so far, refused to negotiate with the group (see “Avaya nets exclusivity extension amid fracas with 2nd-lien group,” LCD News, July 27, 2017).

Prior to that, the crossover group had presented a proposal to the company (see “Avaya crossover group signs NDA, proposes alternate plan for company,” LCD News, May 24, 2017), but the status of that proposal is unclear. Note that the members of the second-lien panel, for the most part, were previously members of the crossover group when its proposal was made, but have since split off. — Alan Zimmerman

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Prepare, Don’t Panic for the Move Away from LIBOR – Guest Analysis via LSTA

This analysis on the future of LIBOR is courtesy of LSTA Executive Vice President of Research & Analysis Meredith Coffey.

Since the LIBOR speech by Andrew Bailey, Chief Executive of the FCA, on July 27, markets have been buzzing about whether LIBOR is ending, when it might end, and what loans and CLOs would do.

On Aug. 17, the LSTA hosted a webcast walking through i) why LIBOR might end, ii) what the replacement might be, and iii) ways to approach loans and CLOs. We recap these issues below and encourage you to visit the LSTA’s webcast page for slides and a replay.

Exposure to LIBOR by Asset Class

To put the enormity of the LIBOR issue into context, one should realize that exposure to LIBOR tops $150 trillion (that’s trillion with a “T”) across asset classes. So, it is a big issue.

Bye … But why?
Why might LIBOR go away? First, there were widespread allegations of manipulation by LIBOR submitters during the financial crisis. This led to jail terms and billions of dollars of fines. As a result, LIBOR submitters now have liability, and this makes banks unenthusiastic about submitting. In addition, there simply isn’t much liquidity in the underlying LIBOR market. More than 70% of three-month dollar LIBOR submissions were based on “expert judgement” by submitters, not actual transactions or interpolation of transactions. All regulators are concerned about LIBOR liquidity, but the FCA, in particular, made waves last month when it announced it would not compel banks to submit LIBOR after 2021. (The subtext was that LIBOR may well go away thereafter.)

While the LIBOR issue may have come as a surprise to some, in reality, industry and regulators have been working on it for years. In 2014, FSOC recommended that regulators work with market participants to identify new benchmarks and develop a plan to transition to a new benchmark. And, lo, the Alternative Reference Rates Committee (“ARRC”) was formed. After nearly three years of work, in June 2017, ARRC announced its preferred alternative reference rate—the Broad Treasuries Repo Financing Rate (or BTFR).

BTFR?
This rate, which is the cost of overnight loans that use US government debt as collateral, has much to recommend it: It is transactional, liquid and deep (with an average daily trading volume of $660 billion), it will likely remain robust, and it satisfies IOSCO’s Principles for Financial Benchmarks. But there are cons for loans: BTFR is an overnight, secured rate. Thus, even with compounding, it is backwards-looking and it is materially lower than LIBOR. And, FYI, it doesn’t exist yet. The FRBNY will begin publishing it mid-2018.

So this raises a number of questions. First, assuming it is possible to build a forward-looking BTFR term rate, is this the right rate for the loan market? Moreover, how do the loan and CLO markets prepare for a rate that does not exist yet? There are issues to consider both with legacy loans and CLOs, as well as ones that will be issued in the coming years.

Fallbacks
On the loan front, things are a bit more settled. Credit agreements often provide fallbacks in case LIBOR is unavailable. The first fallback typically is that, if the screen rate is unavailable, the definition of LIBOR may provide for the use of i) an interpolated rate, ii) the offered quotation rate to first class banks for deposits in the London interbank market and/or iii) quotes from designated “reference banks”. The second customary fallback is the “market disruption event” clause. Upon a trigger event, lenders can suspend making LIBOR loans and LIBOR loans become base rate/prime rate loans.

To be fair, these LIBOR fallbacks were designed for temporary disruptions, not the death of LIBOR. But with no replacement rate in the offing yet, it is likely too early to draft for a new benchmark. Instead, market participants should understand their existing fallback and amendment provisions in case LIBOR is discontinued. For new agreements, parties might consider hardwiring an ability to amend the credit agreement to address a new benchmark with less than 100% lender vote.

CLOs: A tiered approach?
Loans, because they are made to be amended, are in a better spot than CLOs. Existing CLO indentures typically specify the source of LIBOR and have methods (polling banks, using the last observed rate) if the LIBOR source is not available. However, amending CLO indentures is difficult and, in some cases, impossible. A LIBOR amendment would typically require 100% vote of each class and majority of equity. So, any LIBOR amendment probably should be done in the context of a reset or a refinancing where all holders of non-refinanced classes are known. The good news, though, is that if LIBOR is discontinued after 2021, most existing CLOs may well be in wind-down mode (or post-non-call) already.

The market is attempting to coalesce around approaches for new CLOs. First, there are discussions about switching to “reference rate” terminology. LIBOR initially would be the reference rate, but there would be methods for alternatives. For instance, there is discussion around i) having a fallback rate implemented without amending the indenture, ii) having specified alternatives implemented with an amendment subject to certain objection rights, or iii) having specified alternatives implemented with an amendment requiring certain consents and possibly ratings confirmation.

This tiered approach anticipates that the impetus for modifying the reference rate could range from a clear certainty that LIBOR will no longer be reported to a situation where LIBOR continues to be reported but is no longer prevalent as the reference rate in the leveraged loan market. It would provide options for the selection of the replacement rate under circumstances that might run the gamut from an industry standard that develops quickly to a substantial period during which a number of alternatives compete for market share.

Having a relatively quick and inexpensive option for cases where greater certainty develops and reserving amendments requiring significant levels of consent for situations with less certainty will provide much-needed flexibility as a more definitive path forward develops. The goal is to coalesce around a set of options in the near term that balances the interests of all parties.

In conclusion, the possible transition from LIBOR to another reference rate is a process, not an insurmountable problem. Many entities have been working on the process for years and no one—particularly regulators—is interested in a market disruption. On the LSTA front, we will continue gathering and providing information, we will be involved in a LIBOR replacement for loans as appropriate, and we will work with loan and CLO market participants to further develop LIBOR fallback and transition language.—Meredith Coffey ([email protected])

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Video: European Leveraged Loan Mart Hosts Healthy Buyout Issuance in July

In this month’s Capital Markets View video, LCD’s Taron Wade and S&P Global’s Chris Porter analyze the July European leveraged loan market, and look at where it might be headed going forward.

Discussed this month:

  • Broad-based capex growth is expected in 2017 in Western Europe after four years of decline, according to an S&P Global Ratings survey.
  • European default rates are down at roughly 2%, compared with a 3.3% historic average.
  • Loans have performed better than bonds when it comes to recoveries, with a recovery rate of 74% for first-lien loans, and 52% for bonds (exc. super-senior facilities), according to S&P.
  • The market hosted healthy buyout issuance in June/July, while recaps and refinancings also took a chunky share of the overall volume. Breaking down the latter category, there was a surge of recaps in July.
  • Looking at dividends extracted via the loan and bond markets, the YTD volume (to July) is already ahead of 2016’s full-year tally on this measure.
  • LCD’s forward loan calendar is at an elevated level, swelling to €6.2 billion in the last reading (Aug. 11), which is higher than any time since September 2015. The current pipeline signals strong prospects for buyout activity.

The URL for the video: http://www.spratings.com/en_US/video/-/render/video-detail/capital-markets-view-august-2017

Taron Wade heads up LCD’s European Research efforts. Chris Porter is Head of Loan Recovery & CLO Business Development, S&P Global.

As ever, please feel free to contact Taron or Chris if you’d like a particular topic discussed in next month’s video.

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Risk-off: US High Yield Bond Funds See $2.2B Cash Withdrawal

US high yield bond flows
U.S. high-yield funds recorded an outflow of $2.2 billion for the week ended Aug. 16, according to weekly reporters to Lipper only. This comes on the heels of last week’s $123 million inflow.

ETFs accounted for the bulk of the outflow this week, with an exit of $1.25 billion, while mutual funds saw an outflow of $935 million.

The year-to-date total outflow is now $8.5 billion, including a roughly $9.6 billion outflow from mutual funds and $1 billion inflow to ETFs.

The four-week trailing average dipped into negative territory, after two consecutive weeks in the black, falling to negative $473 million, from positive $630 million last week.

The change due to market conditions this past week was a decrease of $346 million. Total assets at the end of the observation period were $207.8 billion. ETFs account for about 23.5% of the total, at $48.9 billion. — James Passeri

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European Share of High-Yield Bond Markets Grows, Increasing Choices for Issuers

Long gone are the days when companies looking to issue high-yield bonds had one just choice, the U.S. market. For while global high-yield volume has been falling in recent years — with the exception of this year, when it is on the rise — the impact of the European market is growing as it matures. Moreover, with the two markets having some different characteristics and at different stages of the credit cycle, players on both sides of the Atlantic now have far greater choice and flexibility when it comes to choosing which region to raise financing or invest in.

High Yield Bond Volume

Global high-yield volume peaked at $415 billion in 2013, and Europe accounted for 29% of this supply. That was the first time Europe had accounted for more than a quarter of the global total, and since then it has on average made up 28% of the volume each year. So far this year, Europe has offered 36% of the global tally — which would be a clear record if sustained until year-end, and highlights the region’s growing importance.

Cross-Border High Yield Bond Volume

Cross-border volume has fallen sharply from $45.2 billion and $48.7 billion in 2014 and 2015 respectively, to $27.3 billion last year, while just $7.2 billion of such supply has been raised to far this year. This is partly due to fewer jumbo debt raises needing to happen that require liquidity from both markets, as well as increased use of the loan market, but bankers admit the different yields on offer in both bond markets mean it’s often more cost-effective to do two standalone deals rather than a cross-border transaction.

Based on pure new-issue yield comparisons it has been cheaper for a company to raise debt in Europe since the middle of 2013, though large cost-savings for single-Bs weren’t clear until late 2015. Moreover, for both single- and double-B rated credits, average 90-day new-issue yields in Europe have never been lower than they are currently — at 5.41% and 2.91%, respectively. In the U.S., the yields for the same cohorts are 6.73% (this was lower in 1Q17 and 1Q15) and 4.85% (a record low). As such, U.S. double-Bs print a little cheaper than European single-Bs.—Luke Millar

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CDPQ to Grow Private Debt Business with Hire of Hetu, Others

cdpqCaisse de dépôt et placement du Québec (CDPQ) is continuing its push into the U.S. private debt sector with the hire of Robert Hetu, who will lead CDPQ’s efforts in that market.

Hetu joined CDPQ in June from Credit Suisse, where he was a managing director in the investment banking department, leading the corporate lending team. Prior to CS Hetu was a senior manager in structured finance at Societe Generale in Montreal. He will be involved with sourcing U.S. private debt opportunities.

In addition to Hetu, CDPQ will hire to expand their private debt efforts in the next year, in Montreal and London. The long-term vision is to expand private debt efforts across the Atlantic, into Europe. CDPQ’s credit strategy is separated into four areas: corporate credit, specialty finance, real estate, and sovereign credit. Private debt, across these four areas, makes up $32.4 billion of the $66.7 billion fixed income portfolio, according to the company.

Jim McMullan, senior vice president in charge of the corporate credit team at CDPQ, explains that the gradual push toward leveraged finance is “not a revolution, it’s an evolution” motivated by “higher returns for [their] clients with the specter of higher interest rates.” CDPQ’s private debt strategy focuses on the upper middle market.

While there is no firm investment criteria concerning company size, the firm “focuses on more sizeable investments of $100+ million positions in a single investment,” according to McMullan, who stresses that CDPQ “wants to [work] with partners versus being the sole underwriter,” and aims to invest across the capital structure. As an example, McMullan referenced CDPQ’s $1.9 billion investment to support SNC-Lavalin’s acquisition of WS Atkins. The firm provided $1.5 billion in debt and $400 million in equity.

“The push towards leveraged finance opportunities is more people-intensive,” McMullan says. “Historically, there have been around 10 to 15 people on the corporate credit team, and we expect within the next year to be around 20.” — Shivan Bhavnani

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The August Leveraged Loan Market Deal Frenzy Continues

The U.S. leveraged loan market shows no sign of slowing down.

Another 27 deals were allocated market last week, making it the busiest week in the past six months (based on transaction count).

Presuming all deals currently in market close before month-end, and taking into account the 42 that already have broken for trading since the end of July, August is on target for a whopping 93 transactions, according to LCD. That’s the third-highest number on record, behind the 123 in February 2013 and 97 in May of the same year.

The last time investors saw such a frenzied pace of activity was in the second week of February, when 30 transactions broke into the secondary.

The market has picked up steam after just three deals broke in each of the first two weeks of July. For reference, the weekly high for 2017 is 33 deals, toward the end of January.

First-lien loans breaking into secondary

In the last three weeks, 64 transitions have allocated. That’s the busiest three-week stretch since the period ending April 21. Moreover, it’s nearly five times the number of deals that were available to investors during the first three weeks of July. The three-week record so far this year: 95 deals during the period ended Feb. 10.

First-lien loans breaking into secondary, rolling 3 weeks

Based on deal volume, last week’s activity was less spectacular. Some $7.5 billion of loans entered the secondary, a six-week high, but far below the double-digit figures seen throughout the first half of 2017. For example, the last week of June saw $15.3 billion of loans price, the most since the $18.7 billion the week ending April 21. The most this year was the week ending Feb. 3, when $23.1 billion priced.

The reason for the impressive deal count but relatively muted volume is the recent return of repricings (the six-month call premiums on the record number of January repricings are beginning to fall away, of course). These transactions are typically done via amendment, meaning they are not included in volume figures. Out of 42 deals that have broken so far in August, 20 have been repricings. Moreover, the remaining 22 deals were relatively small, with only three exceeding $1 billion (Atlantic BroadbandScientific Games, and Parexel).—Marina Lukatsky

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Staples Wraps $1B High Yield Bond Offering Backing Sycamore LBO

Staples has completed a $1 billion offering of eight-year notes at the wide end of talk, sources said. Bank of America Merrill Lynch was lead on a bookrunner group that included 10 additional banks. Proceeds will be used to back the issuer’s $6.9 billion buyout by Sycamore Partners. The transaction was downsized from $1.3 billion. A concurrent first-lien term loan also backing the LBO transaction was increased by $200 million, to $2.9 billion. There has also been a $100 million decrease in funded debt, sources said. Prior to launching, the borrower had planned for $1.6 billion of the bonds, but steered $300 million to the TLB to meet investor demand. A $1.2 billion ABL facility will also be put in place to back the LBO. The buyout is expected to close in 2017. Terms:

Issuer Staples (Arch Merger Sub Inc)
Ratings B–/B3
Amount $1 billion
Issue Senior (144A/Reg S-for-life)
Coupon 8.5%
Price 100
Yield 8.5%
Spread T+637
Maturity Sept. 15, 2025
Call non-call three (first call at par + 50% of coupon)
Trade Aug. 14, 2017
Settle Aug. 28, 2017 (T+10)
Joint bookrunners BAML/UBS/DB/CS/RBC/JEFF/FifthThird/GS/C/KKR/ Natixis
Price talk 8.25% area
Notes Downsized from $1.3 billion; up to 40% equity claw @ 108.5 until Sept. 15, 2020; change-of-control put @ 101; make-whole @ T+50

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