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Leveraged Loans: As Cov-Lite Levels Grow, Debt Cushion Shrinks

cov-lite cushion
Covenant-lite has all but defined the $1 trillion U.S. leveraged loan market lately, as increasing numbers of speculative-grade corporate borrowers take advantage of this debt structure, amid sustained investor appetite in the asset class.

In fact, issuance of cov-lite loans – which are less restrictive for a borrower, and thereby offer lenders less protection than do traditionally covenanted credits – hit yet another record last month. Roughly 77% of all outstanding loans are now cov-lite.

The rapid growth of cov-lite has raised eyebrows, to say the least, as the current borrower-friendly credit cycle enters its tenth year (that’s a long time between spikes in defaults).

But it’s not just the sheer volume of cov-lite outstandings that are important. LCD recently looked at the debt cushion of outstanding loans – the amount of debt in a borrower’s capital structure that is subordinated to the senior loan – and found that, increasingly, today’s cov-lite deals have little or no debt cushion beneath them. This is important because, as LCD research has shown, the lack of a debt cushion significantly lessens what an investor will recover on a loan, if that credit defaults.

How much has this debt cushion eroded? As of May 31, 23% of all cov-lite loans did not have any debt, such as a mezzanine tranche, high yield bond, or other, below the cov-lite facility. That’s an all-time high, and is up from 18% five years ago, and from just 10% at the end of 2007 (shortly before the financial crisis), according to LCD.

As a result, cov-lite loan outstandings are not only at record levels, but a greater portion of these transactions do not have any debt cushion to absorb losses in case of a default. – Staff reports

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Leveraged Loans: Cov-Lite Volume Reaches Yet Another Record High

The amount of leveraged loan outstandings that are covenant-lite hit another record in May, the 13th new high in as many months, according to LCD.

Loan market experts say the preponderance of these more loosely-structured deals will negatively affect recoveries on this debt – once the long-running credit cycle turns, and defaults begin to mount – though opinions vary as to just how severe that impact will be.

To the numbers: As of May 31, 77.4% of U.S. leveraged loan outstandings were cov-lite. The leveraged loan asset class recently became a $1 trillion market, meaning there is upwards of $800 billion of cov-lite loans outstanding, according to LCD.

Cov-lite deals in some ways are structured akin to high-yield (aka junk) bonds, and are less restrictive than fully covenanted loans. Cov-lite credits feature incurrence covenants, meaning an issuer must meet financial tests only if it wants to take particular actions (pay a dividend to its private equity owner, for instance).

Their acceptance in the global leveraged loan market has soared in recent years, particularly as institutional and retail investors pile into the asset class in an effort to take advantage of loans’ floating rating structure, amid continued rate hikes by the Fed. – Staff reports

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Asurian Floats $3.75B Leveraged Loan Backing Dividend to Private Equity Sponsors

In one of the largest credits of its kind, a Bank of America Merrill Lynch–led arranger group has launched a $3.75 billion covenant-lite term loan package for Asurion that will be used to fund a return of capital to shareholders, according to sources. Commitments are due by noon EDT on Wed., June 27.

Dividend deals such as Asurion are seen as opportunistic issuance in the U.S. leveraged loan market, meaning issuers – or their private equity owners – take advantage of investor demand to originate credits, the proceeds of which are returned to the owners. The U.S. leveraged loan market has been red hot of late as investors crowd the floating-rate asset class thanks to ongoing and expected interest rate hikes.

The loan package includes a new $2.25 billion B-7 term loan due November 2024 and a $1.5 billion add-on to the company’s second-lien term loan due August 2025.

Price talk on the first-lien is L+300, with a 0% LIBOR floor and an OID of 99.5. That indicates a yield to maturity of about 5.55%. Lenders are offered six months of 101 soft call protection.

The second-lien guidance is L+675, with a 0% floor and an OID of 99–99.5. At talk, the yield ranges from 9.51–9.61%. Hard calls will be reset to 102 and 101.

A consent fee of 50 bps is offered to first-lien lenders and of 75 bps to second-lien lenders.

The arranger group includes Morgan Stanley, Goldman Sachs, Barclays, Credit Suisse, and Deutsche Bank.

Agencies affirmed Asurion at B+/B1, with stable outlooks, following the announcement of the share repurchase. First-lien facility ratings are B+/Ba3, with a 3 recovery rating from S&P Global Ratings. The second-lien is rated B–/B3, with a 6 recovery rating.

The issuer will also increase its revolver to $230 million and extend maturity by one year to 2023, agencies note.

Existing debt at Asurion includes its $2.6 billion TLB-4 due August 2022 and $3.2 billion TLB-6 due November 2023. Those existing term loans are priced at L+275, with a 0% floor. The original $1.8 billion second-lien term loan was placed a year ago to refinance the existing facility.

Asurion is a provider of wireless handset insurance products. The company is backed by Madison Dearborn, Berkshire Partners, Providence Equity Partners, and Welsh, Carson, Anderson & Stowe, which acquired to business in 2007, as well as other investors, including The Canadian Pension Plan Investment Board. — Jon Hemingway/ Richard Kellerhals

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Fridson: High Yield Covenant Quality Hits New Low

Covenant quality in the U.S. high yield market last month hit its highest level since 2011, according to bond market expert Martin Fridson, per his FridsonVision analysis.

According to FridsonVision, U.S. high yield covenant quality (where 1 = strongest, 5 = weakest) hit 4.65 last month, the lowest it’s been since the inception of that analysis (in 2011).

The previous record for weakest covenants, according to FridsonVision, was 4.61, recorded in June 2015.

For the record, Moody’s covenant quality in May exactly matched that of FridsonVision, at 4.65. Moody’s series’ worst-ever score, however, was 4.68 in June 2017. By either measure, issuers gained in the terms of trade at the expense of investors during May.

Like FridsonVision, Moody’s reported a sharp month-over-month deterioration in May. Its series moved by 0.22, from 4.43 in April to 4.65 in May.  The FridsonVision calculation of the weakening was even more severe, a move of 0.38, from 4.27 to 4.65. This difference reflects different approaches to weighting the rating-category scores.

The degradation in covenant quality between April and May was particularly pronounced in the B rating category, where the average score went from 3.80, to 4.47. Note, however, that the April score for the B category was anomalously strong. It was better than both Ba’s 4.98 and Caa/Ca’s 4.56, whereas the usual pattern is for covenant quality to weaken with each step down the rating scale.

Even though the B score experienced the most severe weakening among the three ratings categories during May, it ended at a substantially better level, 4.47, than its worst-ever 4.61. In contrast, the Ba category’s May score of 4.97 was just 0.03 shy of its all-time worst of 5.00. The Caa/Ca score of 4.56 was also 0.03 away from its worst-ever reading, which is 4.59.

This information was excerpted from Marty’s weekly analysis, available in full to LCD News subscribers.

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PetSmart Downgraded to CCC due to Likelihood of Debt Exchange

S&P Global Ratings has downgraded PetSmart to CCC, from CCC+, citing an increased likelihood of the company pursuing a debt exchange over the next 12 months that would be viewed as distressed.

“Although the company does not have any meaningful near-term maturities and liquidity is likely to remain adequate, we think PetSmart’s capital structure is unsustainable given the continued weak results at its brick-and-mortar retail stores and operating losses at Chewy,” analyst Andy Sookram said in the report.

S&P revised its recovery rating on the company’s $4.3 billion first-lien term loan and its $1.35 billion of senior secured notes to 4, from 3, to reflect the release of Chewy.com as a guarantor under the term loan and the senior secured notes.

This allows the unsecured noteholders to share any residual value of Chewy.com on a pari passu basis with any deficiency claims of secured term lenders and noteholders. S&P also revised the recovery rating on the company’s

 

$1.9 billion of senior unsecured notes due 2023 and its $650 million of senior unsecured notes due 2025 to 5, from 6, reflecting its view of improved access to value that unsecured creditors have at Chewy.com pursuant to the release of the guaranty. (See “PetSmart unsecured bonds rally on Chewy spin-off news,” LCD News, June 4, 2018. $)

Chewy.com still guarantees and provides collateral to the ABL lenders.

Phoenix-based PetSmart faces significant headwinds in its strategy to turn around operations, which have been hurt by heightened competition from other online retailers, regional pet supply stores, and mass channel operators.

S&P sees a greater probability of a debt exchange or restructuring following the recent dividend to parent Argos Holdings that represents 20% of Chewy.com’s outstanding common stock. As a result, PetSmart’s ownership of Chewy.com has been reduced to 80%. This transaction could facilitate a potential separation of Chewy.com from PetSmart’s consolidated operations, which could occur either through additional dividends to the parent company, a potential sale, or a combination of these alternatives.

Following an EBITDA drop of about 30% for the last twelve months ended April 29, S&P views PetSmart’s capital structure as unsustainable given its forecast for continued EBITDA declines. The company’s $750 million asset-based revolver remained undrawn, with cash on hand at $331 million against debt of $8 billion. — Rachelle Kakouris

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Private Equity Shops Bulk Up on Leveraged Loan Add-On Deals

add-on deals

Private equity–backed companies looking to grow through acquisitions have been an active lot in the U.S. leveraged loan market this year.

Institutional loan issuance backing sponsored add-ons that fund M&A has surged to an all-time high for the first five months of 2018 (this data includes all deals launched through June 5).

At $38.6 billion, this add-on volume is 44% higher than the comparable YTD total in 2017, which itself represented the previous peak during this observation period. Despite the year-over year rise, it’s worth noting that the full-year 2017 total was a record $64.4 billion of sponsored add-on issuance, 58% of which was booked between June and December.

In addition to high LBO supply, escalating purchase price multiples are another reason for rising add-on M&A. PE firms are increasingly focused on growing existing portfolio companies via synergistic tuck-in acquisitions that can help reduce the average cost of a transaction over time. – Jon Hemingway

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AAA CLO Spreads Continue to Rise Amid Supply Surge

AAA spreads

After tightening below the psychological 100 bps mark earlier this year, AAA spreads of five-year reinvestment period CLOs have been widening since March due to a heavy supply of both new issue CLOs and reset of existing deals, according LCD.

AAA spreads, which make up about 60% of a CLO’s total financing costs, touched a post-crisis low of 93 bps in March. They averaged 98.47 bps over the month, before a pickup in resets and an active new-issue pipeline increased average spreads to 102.53 bps in April and to 108.06 bps in May.

CLOs – collateralized obligation vehicles – are special-purpose finance vehicles set up to hold and manage pools of leveraged loans. The vehicles are financed with several tranches of debt (typically starting with a triple-A rated tranche, then proceeding down the ratings ladder, to subordinated debt) that have rights to the collateral and payment stream, in descending order.

They are a critical part of the leveraged loan investor universe, and their issuance has boomed over the past few years as cash-rich institutional investors struggle to find higher-yielding investments.

From an LCD News story by Andrew Park. Follow Andrew on Twitter.

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Leveraged Loans: LIBOR Spread for Riskiest US Borrowers Hits YTD High

single b spreads

After hitting record lows at the end of 2017, spreads offered to the riskiest issuers of U.S. leveraged loans are rising.

As of June 8, the average spread over LIBOR for single-B rated borrowers hit 354 bps over LIBOR, according to LCD. That’s the highest it’s been all year, and is up from L+343 at the end of April and from L+338 at the end of December (their lowest point since the financial crisis of 2007-08).

The rise in single-B spreads comes as those borrowers swarm to a U.S. leveraged loan market still flush with investor cash. In the second quarter to date, 73% of new-issue loan activity is courtesy single-B issuers, up from 63% during the first quarter, according to LCD.

While demand remains strong, however, investors have started to push back on at least some deals, helping spreads in the segment level off.

Last month, for instance, Lifescan, which markets blood-glucose monitoring systems under the brand OneTouch, approached the leveraged loan market for $1.7 billion in financing backing private equity sponsor Platinum Equity’s carve-out of the unit from Johnson & Johnson. The $1.4 billion first-lien portion of the loan package was offered to investors at L+450, but was increased to L+600 last week (the discount on the deal was increased, as well).

B+/B2 rated Lifescan was one of a growing number of leveraged loan price flexes favoring investors, after a decidedly more issuer-friendly market (though investor appetite remains substantial). For loans entering the U.S. secondary market, the ratio of price-flexes favoring issuers was 1.6:1 in May, compared to a lop-sided 25:1 in January, according to LCD. – Staff reports

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Leveraged Loan Issuance Gains Steam in Europe, thanks to LBOs

europe leveraged loan issuance

Strong demand from collateral loan obligations helped European loans work through a generally volatile May to post strong new-issue volumes.

M&A was the clear driver for European loans in May, providing €8.5 billion (when including LBO and other related deals) out of a total new-issue volume of €10.5 billion, according to LCD. This meant M&A was responsible for roughly 81% of deals last month, following a not-too-dissimilar share in April (when acquisition-linked loans brought a nearly 90% of supply).

This M&A-led market is certainly what investors had been asking for at the start of the year, having been through several refinancing spikes over the previous 18 months or so. These deals had helped keep reported volumes high, but did not always help those players looking to add assets or maintain returns.

Year to date, leveraged loan issuance  in Europe targeted for institutional investors totals €41 billion, on par with activity at this point last year. – David Cox

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US High Yield Bond Market Stumbles Through Uninspiring May

US high yield issuance

In what is typically an active period for the U.S. high-yield market, just $15.3 billion of deals were issued in May, making it the lightest volume for that month since the paltry $9.5 billion in recession-era May 2010, according to LCD. Muted issuance came amid the noisy breach of the 3% threshold by the 10-year Treasury, political issues in Italy, simmering geopolitical concerns, and a relatively early Memorial Day.

May’s supply was spread across 33 tranches, up slightly from the 29 tranches finalized in April, though April’s volume was higher, at $16.7 billion.

After gaining in April, following two consecutive monthly declines, the average yield for new issues again fell, dropping 22 bps, to 7.12% in May. This figure, though, is 27 bps higher than the year-to-date average for new issue yields, according to LCD.

YTD, U.S. high yield issuance totals $96.55 billion, down 21% from the $123 billion at this point last year, according to LCD. In contrast, the floating-rate leveraged loan market has seen $237 billion of institutional issuance. That’s down 10% from 2017 (which was a record year for loan issuance, at $503 billion). – Jakema Lewis

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