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After 2-Month Surge, US Leveraged Loan Issuance Stalls

US leveraged loan issuance

Issuance of U.S. leveraged loans dipped sharply in July after a ferocious stretch of activity the previous two months, according to LCD.

Institutional term debt volume slumped to $29 billion last month as loan investors continued to digest the roughly $108 billion that was launched to the syndications market in May and June.

Institutional credits are term loans with little or no amortization. Because they’re somewhat riskier than amortizing term loans, which are repaid on a regular schedule, and revolving credits (together known as pro rata debt), they are more richly priced, and in greater demand to a broad swath of a growing investor base.

Year to date, U.S. institutional issuance totals $300 billion, down 9% from the same period last year, when there was a record $503 billion recorded, according to LCD.

The U.S. leveraged loan market has grown rapidly over the past few years, and earlier in 2018 topped $1 trillion in size. Because of its floating-rate nature, loans have been in demand from both institutional and retail investors of late. That demand has enabled borrowers to demand thinner spreads and notably looser loan structures, prompting concern from those involved in the market, and on the sidelines, as to how these often-hefty credits will fare once the current, long-running credit cycle turns.  – Staff reports

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Amid Surge of Deals, Risk/Reward on US Leveraged Loans Hits 6-Year High

Long-suffering investors in the $1 trillion U.S. leveraged loan market saw some relief in 2018’s second quarter, as the reward for participating in LBO loans, vs the risk incurred, hit its highest level in six years, according to LCD.

For this analysis LCD employed yield per unit of leverage (YPL) to gauge risk/reward, and looks only at loans backing LBOs.

Specifically, in the second quarter, U.S. loan investors saw an average 126 bps of YPL on LBO loans offered in the syndications market, up sharply from 95 bps in the first quarter. To calculate YPL, the yield to maturity of a credit is divided by the deal’s total leverage (debt/EBITDA).

It’s important to note that this increase was almost entirely a result of higher credit spreads in the market, as opposed to an increase in LIBOR, on which U.S. loan pricing is based (three-month LIBOR climbed steeply in Q1, but largely held steady in Q2).

The brighter risk/reward scenario for U.S. loan investors came as cash inflows from retail players – via loan funds and ETFs – slowed, compared to heavy net deposits earlier in the year. The relative slowdown, combined with a hefty $25 billion of LBO loans entering the market in May and June, had investors in the rare position of calling some shots during the syndications process in July, forcing increasing numbers of issuers to sweeten pricing and/or alter terms. Hence the notable increase in YPL (and spread per leverage).

After a slow start, however, loan issuance in the latter half of July has picked up, with issuer-friendly price flexes resuming, so it will be interesting to see how the risk/reward profile in the leveraged loan market shifts going forward. – Staff reports

This story was abstracted from a longer piece of analysis by LCD’s Marina Lukatsky.

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European Leveraged Loans: Ares Prices €463M CLO; YTD Issuance: €16.7B

Bank of America Merrill Lynch has priced an upsized €463.15 million Ares European CLO X for Ares European Loan Management.

The deal was upsized from €412.05 million, with the triple-As seeing the largest increase. All tranches came in line with guidance except the double-As, which came a touch wider.

Details are as follows:

Aries CLO 2018-07-26

The deal will settle on Sept. 6, and matures Oct. 15, 2031. The non-call period ends Oct. 15, 2020, and the reinvestment period ends on April, 15, 2023. The WAL test is 8.5 years.

The deal complies with European risk retention, with the manager taking a horizontal strip.

Ares priced its last CLO — the €413.7 million Ares European CLO IX — via Goldman Sachs in February, with the triple-As paying plus 68 bps on the floating-rate tranche.

This transaction takes the July new-issue numbers to eight deals for €3.3 billion, which is the largest monthly deal count and volume this year.

The year-to-date European CLO deal count and volume is now 40 for €16.7 billion, versus 26 for €10.45 billion in the same period last year. — Luke Millar

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Free Webinar: 2Q18 Global High Yield Outlook (with Marty Fridson)

LCD/S&P Global Market Intelligence’s webinar detailing the second-quarter 2018 high yield markets, and a look ahead to the second half of the year, is now available to view free, on-demand.

This presentation features analysis from Marty Fridson of LCD and Lehmann Livian Fridson Advisors, along with John Atkins, Luke Millar, and Ruth Yang of LCD.

You can view the webinar here.

hy default recessions

In this quarter’s presentation:

  • Today’s dire high-yield headlines, vs. market realities
  • U.S. high-yield issuance sinks …
  • … though M&A/LBO share of market rises
  • HY prices in the secondary soften noticeably
  • European high-yield issuance sinks, as well …
  • … with a host of offerings pulled from market
  • High-yield spreads rise in the U.S. and Europe

hy prices

LCD presents these high-yield market updates each quarter.

The charts used in the presentation are available for download.

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Default Protection on Whirlpool Debt Hits 2-year High as Costs, Tariffs Bite

whirlpoolThe cost of buying protection on the debt of Whirlpool yesterday tested the highest readings since the shock Brexit vote late in June 2016, after the appliance maker detailed a difficult second quarter on rising raw material input costs, transportation setbacks, and uncertainty regarding the emerging tariff regime.

Five-year CDS referencing Whirlpool debt increased nearly 15% yesterday morning, with bids at 95 bps, from 83 bps at the start of this week, according to Markit. Costs haven’t held north of 100 bps since the oil-rout days of 2016’s first quarter, and readings were below 50 bps as recently as late January, when President Trump’s initial tariff impositions appeared narrowly tailored to specific products, including imported washers.

Whirlpool today revealed a material $50–100 million increase in its raw-material cost assumptions for the year, now putting the year-to-year increase at roughly $350 million. The company noted some protections against rising steel cost inputs from contract hedging, but lamented its inability to hedge mounting costs for critical resins as oil prices trend higher. It also warned that freight costs were a freshening headwind amid higher fuel costs and an imbalance between heated demand and the more limited availability of freight carriers.

While the company is still positive on the medium- to long-term benefits of tax reform to consumer demand and corporate competitiveness, it also said it was beginning to feel the pinch of tariffs, either as a direct importer or via its suppliers, adding to the weight of cost inflation. Its efforts to cull running costs from its structure helped bolster EBIT margins through a rough patch in its European operations and a steeper-than-expected 4% decline in consolidated 2Q revenue, but Whirlpool now faces a tightrope exercise in attempting to pass through its higher production costs to consumers amid crosscurrents in global macro demand.

“Since mid-May, a number of elements in the macro environment worsened significantly. In addition to continued raw material inflation, we experienced a temporary but significant decline in U.S. industry demand, headwinds related to the U.S. tariff as well as the Brazilian trucker strike and currency fluctuations in Russia and Latin America,” CEO Marc Bitzer said on today’s call with analysts. “In Europe, we were unable to overcome macro headwinds due to slower progress when expected as we work to recover volumes in the region.”

He went on to note the expected benefit to free cash flow from leaner inventories, strong product mix trends, working capital optimization, and reduced structural costs. Still, the projection for free cash flow of roughly 4% of net sales for all of 2018 is shy of the company’s stated long-term goal of 5–6% and a downshift from projections at the start of the year.

On the liquidity front, Whirlpool on April 24 announced the sale of its Embraco subsidiary to Japan’s Nidec for roughly $1.1 billion, the proceeds of which backed a $1 billion share repurchase via tender offer. The company said today that it would continue to buy back shares under its remaining $950 million authorization.

Whirlpool during the quarter also entered into a term loan agreement via a Wells Fargo–led lender group, providing for an aggregate lender commitment of €600 million (roughly $703 million) which was earmarked for general corporate purposes, including the repayment of commercial paper. — John Atkins

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Covenant-lite Leveraged Loans: After Default, Whither Recoveries?

Covenant-lite has been the talk of the leveraged loan market for a while now.

Specifically, when the current, long-running credit cycle finally turns, how much less will investors recover on these loosely structured deals, if they end up in default, than on defaulted loans offering traditional safeguards?

covenant-lite loan recoveries

It is far from an academic question. Right now roughly 78% of the more than $1 trillion in outstanding U.S. leveraged loans are cov-lite, compared to just 29% in 2007, at the peak of last credit cycle (and just before the financial crisis).

Cov-lite loans place fewer restrictions on a borrower than do traditionally structured credits. They have soared in popularity over the past few years as institutional and retail investors have poured tens of billions into the U.S. leveraged loan asset class, looking to take advantage of continued rate hikes by the Fed – leveraged loans are floating rate – and, recently, a steady rise in LIBOR.

For a glimpse into how the current cov-lite market dominance might hinder recoveries on leveraged loans in cases of default, LCD looked at average recoveries on cov-lite credits undertaken prior to 2010 – before the financial crisis – and those undertaken after 2010 (so-called cov-lite 2.0), using data from LossStats.

While the data set for recent-vintage cov-lite loans that have entered and emerged from the default/distressed exchange/bankruptcy processes is necessarily thin – leveraged loan default rates have been stubbornly low for much of the current credit cycle – it offers insight into how today’s cov-lite loan binge might impact recoveries.

Specifically, the average discounted recovery rate on cov-lite loans undertaken before 2010 is 78%. That figure drops to 56% for cov-lite loans originated in 2010 and after, according to LossStats.

For purposes of this analysis LCD has used discounted, as opposed to nominal, recoveries. Because restructurings can last years (and years), eliminating the noise of time is important to maintain comparability. The discounted recovery time-values the nominal recovery back to the date of default using the pre-petition default rate, normalizing recoveries over long periods of analysis, and creating parity among the recovery outcomes from various events.

It is important to note, again, that the data set for cov-lite is thin indeed. There are only 40 of those defaulted instruments in total, and only 13 in the 2010-or-later pool. We should also bear in mind that this pool represents cov-lite debt that has defaulted, then recovered. The lurking danger of cov-lite is not just the risk of poor recoveries. It is also the risk of “zombie” credits that do not default, but simply limp through a prolonged downturn. The costs and risks to investors in that scenario is not captured in these recovery numbers.

That being said, there are clear indicators that cov-lite issued after the credit crunch—the 2.0 incarnation—will be more problematic in recovery than were its 1.0 predecessors.

This story is abstracted from a longer piece of analysis by LCD’s Ruth Yang, based on data from S&P’s LossStats.

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Netflix Eyes High Yield Mart as Bonds Fall Amid Lackluster Subscriber Growth

Bonds backing Netflix (Nasdaq: NFLX) fell late yesterday, alongside a sharp decline in shares of the streaming media giant, after the company reported second-quarter subscriber growth of 5.2 million users—or one million viewers shy of its guidance of 6.2 million.

Revenue for the period of $3.907 billion was 0.8% below analyst forecasts based on consensus data compiled by S&P Global Market Intelligence, while adjusted EBITDA of $563 million topped consensus expectations by 2.6%.

The company’s 5.875% bullet notes due November 2028 and 5.875% notes due February 2025 were off 1.625 points and one point, respectively, after today’s closing bell, changing hands on either side of 100.25 and at 102, according to MarketAxess.

Netflix placed a $1.9 billion offering of the 5.875% notes due November 2028 in April at T+291 via a Morgan Stanley–led bookrunner group. The issue’s spread indications after the bell today were on either side of T+300, or roughly 25 bps wider month to month.

The company also said it is again eyeing the high-yield mart for a new round of capital raising.

“While interest rates have risen and the federal tax rate is now lower (reducing the tax shield on interest costs), we judge that our after-tax cost of debt continues to be lower than our cost of equity, so we anticipate that we’ll continue to finance our capital needs in the high-yield market,” the company said in today’s statement.

Netflix’s streaming revenue in the second quarter climbed 43% from the previous year, driven by a 26% increase in average paid memberships and a 14% rise in average selling price. The company said its operating margin of 11.8% widened 720 bps year-over-year, contributing to a 262% growth in operating income in the period.

“We had a strong but not stellar Q2, ending with 130 million memberships,” Netflix said, adding “in some quarters we will be high and other quarters low relative to our guidance. This Q2, we over-forecasted global net additions which amounted to 5.2m vs. a forecast of 6.2m and flat compared to Q2 a year ago, as acquisition growth was slightly lower than we projected.”

Netflix is a Los Gatos, Calif.–based global streaming media provider. — James Passeri/Jakema Lewis

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Amid Market Pushback, Yields on US Leveraged Loans Rise


YTM US leveraged loans

After dipping to recent lows late last year, yields on U.S. leveraged loans have risen to their highest level since the first quarter of 2016, as investors try to digest massive amounts of new issuance seen over the past few months and begin to push back on some aggressively structured deals.

At the end of June, the average yield to maturity for leveraged loans rated B+ or higher jumped to 5.39%, from 4.94% in May, according to LCD. For lesser-quality loans – those rated B/B2 – the yield to maturity jumped to 6.5% from 6.12% in May.

These numbers detail new-issue yield to maturity on leveraged loans entering the U.S. secondary market.

The jump in yields last month was solely a function of market dynamics, as opposed to an increase in LIBOR, the rate over which these credits are priced. Three-month LIBOR increased from 1.69% at the start of 2018 to 2.36% by the end of April, but has held roughly steady since. This means the increase in yields on offer to investors in June is a direct result of an increase in a loan’s spread over LIBOR (and/or its offer price).

About that surge of loan issuance: The volume of new loan paper entering the U.S. trading market last month slowed little from the torrid pace in May. In June, $50.7 billion entered the market, down just $800 million from the previous month, and well above the $36.4 billion average through the first five months of 2018, according to LCD. That $50.7 billion in June was via 95 deals, compared to 106 in May.

That supply surge has allowed weary investors to push back against aggressive deals. Indeed, the number of loans that had pricing changed during syndication to favor investors in June outnumbered those changed to favor borrowers for the first time since February 2016, according to LCD. – Staff reports

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US Leveraged Loan Market Grows to Another Record in June: $1.05T

us leveraged loans outstanding

The U.S. leveraged loan market in June hit its sixth record amount in as many months, totaling $1.05 trillion, according to the S&P/LSTA Leveraged Loan Index.

The U.S. loan market has grown dramatically since the financial crisis, by some 75%. It now comprises more than 1,000 issuers. In the past few years that growth has been driven both by institutional investors and by retail investors. On the institutional side, issuance of collateralized loan obligtation vehicles has skyrocketed, while retail investors have flocked to loan funds and leveraged loan ETFs over the past few years.

Overall, interest in the market has increased due to expectations of continued rate hikes by the Fed. A rising rate environment tends to boost interest in a floating-rate asset class such as leveraged loans. – Staff reports

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Fixed-Income: Reverse-Yankee High Yield Bond Issuance Soars

reverse yankee

Speculative-grade debt issuers from the U.S. tapped the European high yield bond market at a record pace in 2018’s first half, taking advantage of decidedly cheaper financing costs in that market.

During the first six months of the year there was €8.2 billion of this ‘reverse-Yankee’ activity, an increase from €5.6 billion in 2017’s second half, and well up from levels seen in 2010 through 2014, according to LCD.

Why the surge in reverse-Yankee activity?

single b yields

Simply put, the European high-yield market, via euro-denominated deals, is a less-expensive financing option for U.S. issuers. For lower-rated companies, for instance – issuers rated single B – Europe has during the first half of the year offered financing that averages 156 bps cheaper than in the U.S., according to LCD. That’s up from a 125 bps difference in 2017’s first half.

This analysis was excerpted from a story on LCD News by Luke Millar.

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