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Leveraged Loan Portfolio Managers Foresee Steady Increase in Default Rate, to 2.24% in 2018

Rather than a sudden spike, portfolio managers of U.S. leveraged loans foresee a slow inflection higher in the headline default rate, marked by pockets of distress in certain sectors. With energy having already experienced its own default cycle, retail, broadcasting, and healthcare are seen as the next potential trouble spots.

At the macro level, participants in LCD’s quarterly survey reined in their default forecasts somewhat, but still see a steady increase, with expectations that the loan default rate will end 2018 at 2.24%, from the current 1.91%.

The sentiment is more benign than that expressed in the third-quarter survey, when respondents had forecast a 2018 rate of 2.42%.

Almost all responses regarding where the expected one-year forward default rate will fall, at year-end 2018, were in a range of 2–2.70%.

Default Rate Projection 2018

Further out, loan investors, on average, expect the default rate to finish 2019 at 2.65%. The views here, polled for the first time this quarter, for the most part (80%) ranged from 2.25–3.30%.

Looking back

The end of year is an opportune time to review the accuracy of past predictions.

Defaults within the S&P/LSTA Leveraged Loan Index jumped to 1.95% in November. While still well short of the 2.44% year-end 2017 rate predicted by loan managers this time last year, a potentially substantial default lurks in the shadows. With few expecting iHeartMedia to even hold another earnings call with its current balance sheet intact, a default on the company’s Clear Channel term loans D and E would, hypothetically speaking, push the default rate to a 33-month high of 2.63%.

LCD also asked participants when they expect the default rate to breach 3.1%—the historical average. More than half (67%) now expect this to be a 2020 event (on an intra-year basis), with only 33% expecting the historical average to be breached in 2019. This is down from 93% forecasting 2019 at the third-quarter reading.

— Rachelle Kakouris

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Led by CLOs, Institutional Investors Grab Unprecedented Share of 2017 Leveraged Loan Market

Propelled by first-half cash inflows into loan funds and surprisingly robust CLO issuance throughout the year, institutional investors grabbed an unprecedented share of the U.S. leveraged loan market in 2017. All told, institutions accounted for 90% of primary allocations this year—excluding those taken by deal arrangers—up from 88% in 2016, according to LCD. The institutional investor dominance was consistent in 2017, ranging from 89% of allocations in the first quarter to nearly 94% in the fourth.

Quarterly CLO Volume 2017

One thing that drove institutional investor market dominance this year: U.S. CLO issuance has topped even the most optimistic predictions made at the beginning of 2017, when the specter of risk retention hung heavily over the market. In the year to date, $115.9 billion of CLO vehicles have priced (including $33.8 billion in the fourth quarter), easily topping the $72.3 billion full-year total in 2016.

Of course, as CLO issuance remains in high gear, that investor component gobbles up market share. So far this year, CLOs account for 64% of institutional loan allocations, up from 62% in 2016 and from 50% in the wake of the financial crisis in 2009.

CLO Share of Institutional Market

What’s more, as the segment continues to heat up and investors get more comfortable around the CLO asset class, the market for U.S. CLOs has expanded from a clubby group of asset managers, hedge funds, and banks to now include insurance companies and pension funds across the U.S., China, Korea, Japan, and Australia. — Staff reports

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Ellington Prices $453M Vehicle, Capping Off – Maybe – Suprising Year for US CLO Market

Citi today priced a $452.8 million CLO for Ellington CLO Management, according to market sources. This is the second CLO to be issued from the manager, which debuted in April.

The manager is retaining a horizontal slice to comply with risk retention in the U.S.

Pricing details are as follows:

Ellington_CLO_2017-12-18

The transaction will close on Jan. 30, with the non-call period running until Feb. 15, 2020, and the reinvestment period ending on Feb. 15, 2021. The legal final maturity is on Feb. 15, 2029.

Year-to-date new issuance is now $116.35 billion from 208 CLOs, according to LCD data. New issuance in December is now $8.14 billion from 16 transactions. — Andrew Park

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Campbell Soup Eyes $6.2B Bridge Loan for Snyder-Lance Buy

Campbell Soup Company (NYSE: CPB) disclosed that it has obtained a commitment letter from Credit Suisse providing a $6.2 billion, 364-day senior unsecured bridge term loan in connection with the company’s planned acquisition of Snyder-Lance (Nasdaq: LNCE), which is scheduled to close in the second quarter of 2018.

Pricing on the bridge is tied to a ratings-based grid, ranging from L+100–150 and stepping 25 bps every 90 days. The bridge also includes a ticking fee of 11 bps and non-refundable duration fee of 50 bps that is payable 90 days after closing, with an additional 75 bps and 100 bps after 180 and 270 days, respectively.

Five-year CDS referencing Campbell debt was indicated at 46.5 bps this morning, a nearly 30% increase from readings last week near 36 bps, according to Markit. The protection costs are up from 31 bps at the start of November, and readings below 30 bps as recently as July. The company’s debt is lightly traded and Campbell is not a frequent bond issuer, having last placed notes in March 2015 in a $300 million offering of 3.3% 10-year notes due March 19, 2015 at T+123.

The M&A play drew a one-notch downgrade from S&P Global Ratings, to BBB, and a review for possible downgrade on the current A3 rating at Moody’s. S&P Global Ratings left the outlook at negative, reflecting “the pro forma credit metric deterioration following the acquisition, the inherent integration risks of such a large acquisition, and the risks that Campbell’s Fresh segment will continue to underperform, as well as that Snyder’s-Lance relatively weak margins may not rebound, thus causing Campbell to struggle to reduce leverage below 4.0x over the next 24 months.”

S&P Global Ratings pegged adjusted leverage, pro forma for the transaction, at 4.9x, from 2.2x for the LTM period to Oct. 31, while it sees funds from operations to debt winnowed to less than 15%, from 36%.

The leverage downgrade trigger at the prior rating was 3x. While Campbell is expected to suspend share buybacks for the next couple of years to prioritize debt reduction, S&P Global Ratings does not anticipate credit metrics returning to levels commensurate with the previous rating until at least the fiscal year ending July 31, 2022.

Moody’s said it believes any downgrade would not exceed two notches, and it today affirmed the Prime-2 commercial paper grade.

Campbell plans to finance the acquisition through $6.2 billion of debt, in a combination of both long-term and short-term debt. Pro forma leverage is expected to be 4.8x at closing, according to a Campbell statement, which noted that the company plans to delever to roughly 3x by fiscal 2022.

Under the terms of the acquisition, Campbell Soup will acquire Snyder-Lance for $50 per share in an all-cash transaction. The acquisition, which has been approved by the Boards of Directors of both companies, will enable Campbell to expand its portfolio of leading snacking brands. — Richard Kellerhals/John Atkins

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U.S. Dividend-Related Leveraged Loans Hit Lofty Levels in 2017

The sprint toward year-end by opportunistic issuers has brought 2017 dividend-related loan volume to lofty levels.

With a week or so remaining in the loan market year, institutional issuance backing dividends to private equity sponsors in 2017 totals $42.4 billion, the third-highest amount ever, behind the $51 billion in 2013 and $42.8 billion in 2014, according to LCD.

The impressive YTD number was boosted by a hectic November, in which nearly $8 billion of institutional loans backed dividends to sponsored borrowers, the highest monthly figure since the $9.2 billion in January.

If soaring monthly issuance in a high-profile loan sector bookending 2017 sounds familiar, there’s a reason: Another opportunistic segment—repricings— followed a similar track this year, with record volume in January and prodigious activity in November.

These numbers detail total loan volume backing dividends. As for how much sponsors actually paid themselves through these transactions, this activity also has picked up of late. PE shops have extracted more than $5 billion in the fourth quarter (through Dec. 8), the most since the first quarter ($6.35 billion). All told, private equity shops have used dividend loans to write themselves checks totaling $18.2 billion this year.

Those checks made for an average return on equity of 76% via recaps completed in 2017, with the average time between the LBO and recap narrowing to 3.3 years. (Note: for this analysis, return on equity is calculated by dividing the dividend amount by the original equity contribution at the time of LBO.)

Both figures are down from 2016, when recaps were undertaken an average of 3.7 years after the LBO, bringing return on equity via those transactions to 84%.

On a related note: Sponsored dividend activity in the U.S. high-yield bond market in 2017 ($4.2 billion) was roughly double that in 2016 ($2.2 billion). And, as with loans, most of that volume came late this year. Roughly $3 billion in high-yield dividend deals have been priced so far in the fourth quarter, all of it in November and December. — Tim Cross/Marina Lukatsky

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PetSmart High Yield Debt Tumbles after 3Q Earnings Miss

Debt backing PetSmart was falling more deeply into distressed territory on Tuesday after the privately held pet retailer unveiled lackluster third-quarter earnings, with sources highlighting adjusted EBITDA for the period of roughly $189 million, shy of expectations and down about 34% year-over-year.

“We think this is going to go lower into distressed with retail pressures,” sources noted, highlighting negative fourth-quarter outlook chatter on the issuer’s earnings call yesterday. “People are really going to be focusing on this going forward. There’s definitely a lot of pressure.”

PetSmart 5.875% first-lien notes due 2025 and 8.875% senior notes due 2025—both of which priced at par in May, as part of a $2 billion offering backing the purchase of Chewy.com—were falling in blocks Tuesday by 4.125 points and five points, respectively, according to MarketAxess, to 81.25 and 70.

Meanwhile, the issuer’s B term loan due March 2022 (L+300, 1% LIBOR floor) was off by more than two points on the day, falling to quotes of 82.25/83.25, from bid quotes of 84.5 Monday, sources noted.

The Phoenix-based retailer has most recently been pressured by mounting market speculation over whether PetSmart could split from Chewy.com in a spin-off to sponsors, which could be impeded by restricted-payment covenants tied to the issuer’s senior debt.

Following the PetSmart’s second-quarter earnings roll-out in September, the company’s senior and unsecured debt was also downgraded on Sept. 18 by S&P Global Ratings to B and CCC+, respectively, from B+ and B–, keeping respective recovery ratings of 3 and 6 unchanged. S&P Global also lowered the issuer’s corporate credit rating to B from B+, with a negative outlook remaining in place.

“Factors contributing to our downward revisions include greater competition in the pet retailing space with mass retailers and other online retailers competing aggressively for pet food market share. We also think management turnover will complicate operational and acquisition execution,” S&P Global noted in a Sept. 18 report.

Moody’s maintains a B1 corporate credit rating on PetSmart, with a negative outlook, with Ba3 and B3 ratings on the issuer’s secured and unsecured debt, respectively. — James Passeri/Rachelle Kakouris

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Europe: As Leveraged Finance Market Rolls on, Dividend Deals Near Pre-Crisis Levels

europe dividend loans hy

Private equity shops are paying themselves dividends via junk bonds and leveraged loans in Europe at a rate not seen since before the financial crisis.

Total issuance of debt which backs dividends, all or in part, in these segments (which comprise the overall leveraged finance capital markets) has hit €18.7 billion so far in 2017, nearly matching the record €20.3 billion logged in all of 2007, according to LCD. The recent activity  more than triples the amount seen last year, while the increase funded specifically by high yield bonds is even more dramatic.

High profile activity has reflected this dynamic, with sponsors taking dividends via the bond market over the past month for portfolio companies Lowen PlayRaffinerie HeideHaya Real Estate, and Verisure, with the latter using both the loan and bond market to pay owners a €1 billion dividend (which is on course to be the largest debt-funded shareholder payment since unsponsored Ziggo paid its owners €2.8 billion through a cross-border bond financing in September last year). Demonstrating just how high risk appetite is, the Verisure financing contained a €980 million, CCC+/Caa1 tranche.

To be sure, loan and bond issuance for deals backing dividends has soared. And the amount specifically used for to fund the dividend – as opposed to another recap-related purpose – has likewise climbed, totaling €7.6 billion so far this year, more than twice the amount during all of 2016, according to LCD.

Dividend deals, of course, are more prevalent during overheated credit markets, when institutional appetite for loan or high yield paper outweighs issuance in the sector. While investors generally do not like the idea of a sponsor leveraging up a portfolio company, then extracting cash before the lending institution has been repaid, they often acquiesce, to maintain a good relationship with the sponsor – which are frequent borrowers – and because, in hot credit markets, another investor will almost certainly be willing to step in, if one should drop out. – Staff reports

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Mattel Bonds Tumble on Guaranteed Debt Roll-Out, Ratings Downgrades

Bonds backing fallen angel Mattel fell today after the toy maker rolled out weakened sales guidance for the remainder of 2017, alongside plans to issue $1 billion of unsecured notes, with priority claims that effectively prime its existing unsecured bonds. The new senior notes will be marketed alongside roughly $1.6 billion in new asset-backed lending (ABL) revolving credit, under ratings that were cut again today deeper into junk territory by all three ratings agencies.

Sources noted existing bondholders would end up with the “short end of the stick” in light of the proposed debt launches. Mattel’s corporate and unsecured bond ratings were cut on Monday by S&P Global Ratings to BB–, from BB, with a negative outlook remaining in place and a 3 recovery rating assigned to the proposed new unsecured notes. However, S&P revised the recovery rating for the existing unsecured stack to 4, as existing noteholders are impaired by the ABL revolver in the capital structure and subsidiary guarantees in the new proposed notes, “which result in higher priority claims ahead of the existing notes.”

This marks S&P’s third cut to the issuer’s credit rating since July, when ratings were first cut by one notch from BBB on flagging operational metrics, and then again in October by two notches following the bankruptcy of key retailer Toys R Us in September.

Mattel 3.15% notes due 2023 and 6.2% notes due 2040 bore the brunt of the damage, sliding roughly four points and 5.5 points, respectively, to 90.5 and 93.5, according to MarketAxess. The 2040 bonds traded near 110% of par ahead of the S&P fallen-angel downgrade in October. Meanwhile, the issuer’s 2.35% notes due 2019 were off by about a point, falling to 97.8.

Moody’s today downgraded Mattel’s unsecured bonds to Ba3, from Baa3, and assigned a Ba2 corporate rating on the issuer. Fitch Ratings, meanwhile, downgraded Mattel’s issuer default rating to BB, from BBB–, and its existing senior unsecured notes to BB–, from BBB–. Fitch also assigned a BB rating to Mattel’s proposed $1 billion of senior notes.

Mattel now expects its full-year 2017 gross sales will decline in percentage by at least the mid-to-high single digits compared to 2016, in contrast with June guidance of “mid-to-high single digit revenue growth, and operating profits at, or above, 15%.”

The company today pointed to “key retail partners moving toward tighter inventory management” and challenges facing Toy Box and other underperforming brands.

“The unfavorable year-over-year gross margin experienced during the first nine months of 2017 is expected to continue throughout the fourth quarter of 2017, as a result of unfavorable product mix, higher freight and logistics expense, and lower fixed cost absorption,” the company noted in a Monday filing. “In addition, continued negative trends in top line performance for the balance of the year could result in additional gross margin deterioration as a result of higher inventory write-downs and discounts offered to clear inventory.”

The company added that it expects to achieve in 2018 a third of its projected $650 million in cost savings through 2019, while incurring about $200 million of related severance and restructuring costs between the current quarter and end of 2019.

The company’s CEO, Mary Margaret Hastings Georgiadis, on Oct. 26 emphasized that the company “will clearly not achieve the top line expectation we discussed in June,” based on lackluster quarterly earnings, in which adjusted EBITDA of roughly $227 million fell 31% shy of analyst forecasts, based on S&P Global consensus data, prompting downgrades by both S&P and Moody’s.

Mattel (NASDAQ: MAT) is an El Segundo, Calif.–based toy manufacturer. — James Passeri

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Amid Investor Appetite for Loans, Charter Communications Eyes $12.3B Refinancing Package

Charter Communications last week launched a sweeping loan refinancing proposal that includes a $6.328 billion B term loan due April 2025, a $2.5 billion amortizing term loan due March 2023, and a $3.5 billion revolving credit due March 2023.

Price talk for the TLB – a term loan with little amortization during the course of the credit – is L+200 , offered at a discount of 99.75. That indicates a yield to maturity of about 3.57%. In the U.S. leveraged loan market, L+200 has emerged as a low-pricing benchmark during what has become a sustained period of intense demand from cash-rich institutional investors in search of yield.

Pricing on the pro rata portion – the amortizing term loan and the RC – is outlined at L+150.

Financial covenants include 4x first-lien net leverage and 5x total net leverage tests.

Proceeds will be used to refinance the following existing term loan tranches: TLA-1, TLE-1, TLF-1, TLH-1, and TLI-1.

Current facility ratings are BBB–/Ba1/BBB–. Corporate ratings are BB+/Ba2/BB+.

Charter Communications (Nasdaq: CHTR) provides cable communications services to residential and commercial customers. — Jon Hemingway

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McGraw-Hill Unveils PIK Toggle Offering as High Yield Mart Heats Up

McGraw-Hill has set talk in the 9.5% area for a $250 million offering of five-year (non-call one) PIK toggle notes, sources say. Pricing is expected today, Dec. 7, via bookrunners Credit Suisse (lead) and Jefferies, following the closing of books at noon EST.

Proceeds, along with those from a term loan add-on, will be used to refinance $443.6 million of 8.5% PIK toggle notes due 2019.

The educational concern is the third issuer since the middle of November to come to the high yield market with a PIK toggle offering, which allows the issuer to pay interest with additional debt, as opposed to cash. The other two:

  • Technology/healthcare concern Multiplan last month issued $1.3 billion in PIK toggle notes backing a dividend to private equity sponsor Hellman & Friedman. The offering priced to yield 9.25% (8.5% if repaid in cash). Multiplan was the largest PIK toggle since the financial crisis. The issue was rated B-/Caa2.
  • Lab testing company Sotera in November completed a $75 million PIK toggle offering to yield 8.875% (8.125% if repaid in cash), backing a distribution to sponsor Warburg Pincus. The issue was rated CCC+/Caa2.

As reported, McGraw-Hill is currently in market with a $150 million incremental first-lien term loan. Price talk is for an issue price of 99.75. Commitments are due today. The add-on will be fungible with the existing covenant-lite TLB due May 2022, which is priced at L+400, with a 1% LIBOR floor.

The company has launched a tender offer for the $443.6 million outstanding of its 8.50%/9.25% PIK toggle notes due 2019 at total consideration of $1,002.75 per note, including a $30 consent payment for notes tendered by the early deadline of Dec. 12. Credit Suisse is running the tender. The bonds are also currently callable at par.

The new notes will slip behind its 7.875% senior notes due 2024, which closed last night at par, yielding 7.87%, according to S&P Global Market Intelligence. The 2024s mark its last visit to the bond market, in April 2016.

Current PIK toggle ratings are CCC+/Caa1/B, and term facility ratings are B+/B1, with a 2 recovery rating from S&P Global Ratings. Moody’s earlier this week downgraded the term loan facility rating by one notch. Corporate ratings are B/B2, with stable and negative outlooks.

McGraw-Hill Global Education Holdings is a provider of outcome-focused learning solutions, delivering curated content and digital products to students in higher education, K–12, professionals, and corporations across 140 countries. — Staff reports

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