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Global High Yield Default Tally Dips to Lowest Level in 2 Years

The 2018 global corporate default tally remained at 76 this week, the lowest total for this point in December since 2015, according to a report by S&P Global Fixed Income Research.

The U.S. continues to hold the highest share of corporate defaults this year, with 44 (58% of the total), followed by emerging markets with 16, Europe with 11, and other developed markets (Australia, Canada, Japan, and New Zealand) with five.

By sector, oil and gas leads the default tally with 14 defaults, or 18% of the total, followed by retail and restaurants with 11, or 14% of the total.

Distressed exchanges continue to be the leading cause of defaults in 2018, with 27 defaults, followed by missed principal and interest payments (including defaults on debt obligations) with 24 defaults, bankruptcy with 16 defaults, and regulatory intervention with one default. The remaining eight defaults were confidential.

In terms of the trailing-12-month rate, the U.S. speculative-grade corporate default rate remained at an estimated 2.64% in November, while the European speculative-grade corporate default rate decreased to an estimated 1.93% in November, from 1.94% in October, according to S&P Global. — Rachelle Kakouris

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European Leveraged Loans Lose 0.52% in November

europe leveraged loan returns

The European leveraged loan secondary market encountered treacherous conditions in November, amid a sharp sell-off in global financial markets. And while this weakness sent the S&P European Leveraged Loan Index (ELLI) towards its lowest return since just after the Brexit vote in 2016, it still outperformed its U.S. counterpart and other European asset classes.

In November the ELLI lost 0.52%, which is the worst return since June 2016 (when it declined by 0.60%), and only the second month in the red in 2018 (the Index lost 0.43% in June). On average, loans have gained 19 bps per month so far this year.

For the year through Nov. 30 the Index was up 2.16%, putting 2018 on track to be the worst year for European loan returns since 2011. For reference, the ELLI had gained 4.11% by this time last year. – Marina Lukatsky

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US Leveraged Loans Lose 0.37% Today

Loans lost a hefty 0.37% today after gaining 0.02% 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, lost 0.42% today.

Loan returns are –0.31% in the month to date and 2.74% in the YTD. – Staff reports

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CDO Revival Gains Pace, But These Are Not Your Pre-Crisis Debt Vehicles

The CDO market is slowly picking up steam, with 15 transactions issued since 2015, according to LCD. This year alone has featured in excess of $3.5 billion of collateralized debt obligation activity, more than double that of each of the past three years.

For many, the term CDO immediately evokes the financial crisis, with banks and investors ultimately having to write down tens of billions in losses over the ensuing years.

Consequently, since the crisis, CLOs—which share with CDOs two letters and several structural features—have been working hard to distance themselves from their pre-crisis cousins. But now, GSO, the credit arm of private equity firm Blackstone, recently became the latest high-profile fund to issue its first post-crisis CDO, out of a platform it has named Cirrus Funding.

Other CDO issuers include Anchorage Capital Group, Brigade Capital Management, Fortress Investment Group, and Credit Suisse Asset Management.

Anchorage launched the first post-crisis CDO in Europe in August, and others in that region are expected to follow suit.

Not your pre-crisis CDOs
There are notable differences between the CDOs being issued now versus those from over 10 years ago.

The most noteworthy entails underlying collateral. Many pre-crisis CDOs were filled with subprime mortgage bonds. Subsequent litigation charged that the bulk of the mortgages were fraudulently underwritten, forcing many of the originating banks to eventually repurchase them, or pay large settlements to both investors and regulators.

Today’s iteration of CDOs instead invests strictly in the credit of corporate issuers, whose financials are audited. And in many cases those issuers have a running history with investors in either the high yield or leveraged loan markets.

Part of the growing appeal of the new CDOs is, in fact, due to the regulatory regime. Following the enactment of the Volcker Rule in 2014, CLO managers could no longer purchase a single high-yield bond if they wanted to sell to banks, one of the largest buyers of the senior debt tranches on a CLO. As a result, these new CDOs, which are issued without the intent to comply with the Volcker Rule, allow managers to have the flexibility to switch between investing in high yield bonds and leveraged loans. (The LSTA, incidentally, recently made its case to regulators that CLOs be allowed bond buckets of up to 10%.)

The primary buyers of these new CDOs are insurance companies in the U.S. and overseas. This investor base is particularly interested in these assets given their fixed-rate coupons, which offer an investment grade rating and a long duration matching their liabilities, and exceeding most yields elsewhere in the fixed-income universe.

On GSO’s Cirrus Funding 2018-1, which matures in 18 years, the Aaa tranche (Moody’s) offers a coupon of 4.80%, while the junior-most Baa3 debt tranche pays a coupon of 7.05%.

This time is different?
At first glance, the notion of CDOs receiving investment grade ratings might raise eyebrows, considering this debt’s prominent role in the financial crisis.

These new CDOs certainly are more risky than the CLOs currently in market. However, Moody’s analysts have required more safeguards with these vehicles, compared to CLOs.

Particularly noteworthy in this iteration of CDOs is the ability of managers to buy up to 70% of the portfolio in second-lien loans and/or unsecured or subordinated bonds, according to analysts at Moody’s, who’ve rated all of the latest CDOs.

CDOs are allowed to hold up to 17.5% of their portfolio in Caa rated assets and below, compared to the 7.5% in CLOs, according to Moody’s. A number of the CDOs already have CCC rated assets of roughly 10% in their portfolios, according to trustee reports.

But these CDOs are leveraged at 2–3x, versus the 10–13x leverage of most CLOs, sources say.

On the more conservative end of recent CDOs is the $327 million Brigade Debt Funding II CDO, which Moody’s assigned a weighted average rating factor (WARF)—a numerical estimate of a portfolio’s credit risk, with a higher WARF indicating more risk—of 2748, roughly equivalent to a B2 rating. It is important to note here that the portfolio was only 19% ramped at the time Moody’s looked at the portfolio. For comparison, the median WARF on CLOs issued in 2018 was 2760.

The most recent trustee report on the debut $408 million Brigade Debt Funding I issued in February meanwhile showed that its WARF was 3331.

In order to account for the higher allowance of higher-risk second-liens and unsecured bonds, the analysts at Moody’s have required managers to hold more credit protection to achieve a rating comparable to what they would normally assign a CLO.

For example, on the CDO tranches that have been rated Aaa by the Moody’s analysts so far, those tranches have another 52% of the debt stack below them can absorb any principal losses, compared to those that have 36% of debt below them to get a Aaa rating in CLOs. Lower in the capital stack, this amount is 29% on a Baa3 CDO tranche, compared to 13% for CLOs.

But perhaps forgotten over the years—again, the negatives associated with collateralized debt obligations have been stubborn—are the benefits of how CDOs are structurally similar to CLOs: Namely, they are able to obtain term funding, just on a riskier set of underlying assets. This assumes, however, that defaults are contained so that the CDO doesn’t fail a number of tests, which would cut off payments to the equity holders, many of whom are the managers themselves.

A key test that these CDOs have, compared to CLOs: at least one of them is based on the portfolio’s market value, including a metric known as market value overcollateralization (MVOC). This is important because the CDO can fail those tests if markets become more volatile, and the underlying loans and bonds start selling off, even if they manage to avoid default later. The thresholds for those tests range anywhere from 113–118% in excess of the total outstanding debt tranches.

History may not repeat, but does it rhyme?
CLO investors often point to how well the 2006 and 2007 vintages performed, even as the volatility thereafter was at times frightening, at one point shutting off the equity to nearly half of the CLOs, in 2009. The median cumulative equity distributions on 2006- and 2007-vintage CLOs ended up at roughly 220% and 239%, respectively, according to Morgan Stanley. But those returns did not come easy, as nearly half of CLOs were not receiving equity distributions, as they were failing key tests in early 2009.

A number of investors have pointed to some important differences this time around, however, namely that the credit deterioration then was focused primarily on household debt, instead of corporate borrowers. Today, of course, the amount of corporate borrowing and leverage levels has risen in recent years, while the widespread lack of covenant protections has yet to be tested.

About that corporate borrowing: The leveraged loan market, for one, had grown to about $1.1 trillion at the end of September from $600 billion in 2008, according to the S&P/LSTA Leveraged Loan Index. Today’s larger pool of loans contains a greater share that are lower-rated: 59% are rated B+ or lower, compared to 37% in 2008. There is as much paper outstanding rated B+ and below now as there was total paper in 2008.

The percentage of lower-rated debt continues to be watched because CLOs, and the new CDOs, which are the natural buyers of this debt, have limits on how much they can hold, as mentioned earlier. – Andrew Park

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Volatility, Yes, though European Leveraged Loans Faring Well vs High Yield, Equities

europe nov asset growth

Sentiment in the European leveraged loan market has taken a turn for the worse over the last couple of weeks, forcing loan issuers and investors to adjust — sometimes sharply — as a result. Loan traders have led much of this volatility, although the market looks to be taking its cue from larger moves in high yield, equities, and the U.S. market.

The secondary market illustrates the sudden shift in loan sentiment, with average bids on the S&P European Leveraged Loan Index (ELLI) rising from a summer trough of 98.41 at the start of July to a peak of 99.20 in the middle of October. Since then it has since traded steadily lower, hitting a mid-98 level this week.

Compared with other asset classes, a 75 bps fall would not be much more than a rounding error, and loans remain relatively calm when contrasted with other markets.

“High yield and the U.S. markets are importing volatility into European loans,” said a London-based fund manager. “Conditions in Europe are tough, but the market is still functioning.” Indeed, mapping the comparative performances of equities, high yield, and loans shows how the latter asset class continues to avoid the swings seen in the more heavily traded markets. – David Cox

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US leveraged loans lose 0.90% in November as Asset Class Continues 4Q swoon

US leveraged loan returns

The U.S. leveraged loan secondary market saw a widespread selloff in November amid stock market volatility and some biting losses in broader financial markets. The loan asset class declined 0.90% last month, its worst performance in almost three years, putting the 2018 YTD return behind 2017 for the first time this year, at 3.06%, versus 3.71% a year ago.

The last time the S&P/LSTA Leveraged Loan Index posted a loss of such magnitude was in December 2015, when loans declined by 1.05%. There are many parallels to that period three years ago—global capital markets posted heavy losses across the board, and for loans specifically, new issuance dried up amid heavy withdrawals from retail loan funds.

Loans have now been in the red for two consecutive months, which had not happened since the first two months of 2016. In fact, loans gained an average of 44 bps per month between January and September of this year, entirely from coupon clipping. Although secondary prices gyrated somewhat throughout the first three quarters, on average, market value remained flat during this time. – Marina Lukatsky

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As M&A lags, Europe’s PE shops look to leveraged loans, high yield for dividends

The European leveraged finance markets swallowed five new dividend-related transactions totalling €2.24 billion in November, as a lull in M&A activity in the fourth quarter allowed issuers to hit the market with opportunistic transactions.

For much of the year, such dividend-related issuance has not been possible as M&A transactions dominated the primary market. “We’ve just had a six-week period with no M&A, and it’s been the first real opportunistic window we’ve seen this year,” said one market participant. “When the window is there, why would private equity turn down the chance to return money to shareholders and protect its returns?”

europe sponsored loan volume

 

But while there was a small spurt in dividend recap supply in November, the dominance of M&A activity over much of 2018 means the volume of opportunistic recaps seen so far this year has still fallen well behind some previous years.

The loan market has hosted roughly €5.87 billion of dividend activity so far this year while the bond market has taken €1.41 billion, for a total of €7.28 billion, according to LCD. While this is higher than the totals recorded in 2015 and 2016 on this measure (at €3.67 billion and €5.61 billion, respectively), it is still way behind the record-breaking volume racked up in 2017, when the market was dominated by opportunistic activity.

The dividend recaps seen so far in 2018 have resulted in some €2.64 billion being returned to shareholders via the leveraged finance market, which is well below the average of €4.5 billion for the 2006–2017 period. By contrast, in 2017 roughly €8.15 billion was returned to shareholders from the proceeds of deals in the bond and loan markets. — Nina Flitman

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US Leveraged Loan Default Rate Dips to 1.61%

leveraged loan default rate

Despite two fresh triggers from the embattled retail sector, the U.S. loan default rate fell to a 13-month low of 1.61% in November, according to the S&P/LSTA Leveraged Loan Index

The rate, down from 1.92% in October, has declined significantly after hitting a three-year high of 2.42% at the end of the first quarter.

By volume, the total of default debt outstanding slipped to $15.3 billion in November from $18 billion in October, as four issuers—Pacific DrillingExGen Texas PowerCumulus Media, and Walter Investment Management—rolled off the 12-month calculation.

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Amid Broad Market Downshift, US Leveraged Loan Issuance Slows in Nov.

US leveraged loan issuance

Souring market conditions left U.S. leveraged loan issuers in the lurch last month, as issuance cratered to just $21 billion, the lowest monthly level since April 2016 (excluding August and December readings that are subject to seasonal factors).

The market was perhaps due to slow its pace anyway following a $51.4 billion October, which was the third busiest month of the year, according to LCD.

However, market conditions deteriorated in November amid a sharp equity selloff and continued pressure in the high-yield market. Moreover, investors began pulling money out of the asset class at a rate not seen in some time: Outflows from retail loan funds were logged in four of six weeks through Nov. 28 for a cumulative net outflow of $4.4 billion over that span, according to data from Lipper.

Note: This story details loan issuance for institutional investors. Revolving credits and amortizing term loans are not included in the data.

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US Leveraged Loan Funds See $1.32B Outflow

U.S. loan funds reported an outflow of $1.32 billion for the week ended Nov. 28, according to Lipper weekly reporters only. This is the second consecutive week of outflows of more than $1 billion—marking the largest two-week outflow total in three years—and the third outflow in the past five weeks.

Outflows have now been logged in four of the last six weeks for a cumulative net outflow of $4.4 billion over that span. Despite this week’s result, the four-week trailing average narrowed to $721 million, from $768 million, as a large outflow rolled off.

Mutual funds were again the primary driver of the outflow at $992.2 million, while another $328.3 million was pulled from ETFs. This is the fifth straight week that investors have moved cash out of mutual funds, for a total of $3.2 billion during that period.

With this latest outflow, the year-to-date total inflow falls to $7.3 billion.

The change due to market conditions last week was a decrease of $395.8 million, moderating from a steeper decline last week, but still the third straight week in the red. Total assets were roughly $103.8 billion at the end of the observation period and ETFs represent about 11% of that, at roughly $11.7 billion. — Jon Hemingway

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