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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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Europe’s CLO Market, Already Red-Hot, Looks to Go Green

The world’s first green CLO is on its way amid a growing sustainable finance market and a push from regulators to scale up green investments to tackle climate change.

While the private sector has already been developing markets for green assets, such as green bonds and loans, increased global regulatory coordination is in the offing to support further growth of green financing, in particular the creation of a sustainable securitisation market.

One European manager, which focuses exclusively on investment in clean energy infrastructure, is working on the first green CLO, according to sources. It will also be the manager’s first CLO issue.

global CLO 1Permira Debt Managers took an initial step in March towards creating a sustainable CLO market by making its €362.5 million Providus I vehicle compliant with environmental, social, and governance (ESG) criteria. The manager’s future CLOs are also going to be ESG compliant, sources say.

ESG criteria calls for socially responsible investments and prevents a fund from investing in certain industries (such as speculative extraction of oil and gas, weapons and firearms, tobacco, gambling, and payday lending, among others).

A green CLO focuses on the “E” in ESG. Sources say the upcoming vehicle will invest solely in green sectors and projects that have a positive and so-called “global cooling” environmental impact, such as renewable energy and energy efficient transportation.

A revolution
Sustainable (or green) CLOs, along with other sustainable structured products “are set to turbocharge sustainable finance,” wrote White & Case partners Chris McGarry and Debashis Dey and counsel Mindy Hauman in a client alert in May. “CLOs will be a pillar of the sustainable securitisation revolution,” they added.

The green finance market is still at a nascent stage, but it’s growing rapidly and will benefit from certain accords. Indeed, to reduce climate risk in line with the Paris Agreement, the United Nations estimates that $90 trillion of investments are needed in the next 15 years to build out sustainable infrastructures that include everything from energy to public transport, buildings, water supply, sanitation, and so on. The Organisation for Economic Co-operation and Development (OECD) estimates annual issuance of sustainable asset-backed securities (ABS) could reach $350 billion by 2035 and notes that it is the fastest growing product under the sustainable finance umbrella.

Other forms of sustainable securitisations include ABS made up of sustainable auto loans, solar loans, and Property Assessed Clean Energy (PACE) loans, as well as mortgage-backed securities for green residential and commercial properties.

“We are pushing hard for green securitizations because the scale of investments around the world to achieve low carbon is so vast that the balance sheets of banks are not going to be able to cope, especially as the banks need to recapitalize,” says Sean Kidney, CEO of the Climate Bonds Initiative (CBI), an organization which aims to develop a liquid green and climate bond market and which partners with banks, bond issuers, institutional investors, law firms as well as ratings agencies and other institutions.

Global issuance of green bonds totaled $160.2 billion in 2017, up 85% versus 2016. The CBI forecast for 2018 calls for the global green bond market to grow to $250–300 billion. The U.S., China, and France accounted for 56% of 2017 issuance. U.S. government agency Fannie Mae was the largest issuer of Green MBS in 2017 at $24.9 billion.

Some existing CLO managers are somewhat skeptical about the green securitisation market though, given that it remains relatively niche, but they say the theme is becoming more and more topical.

“We haven’t written ESG criteria into our CLO documentation, but we have ESG watch flags in our investment processes. Lots of institutional investors are stressing the importance of it, but it needs to be clear that this should not only be a marketing strategy to boost reputation,” says one CLO fund manager.

It is not just specialist investors, but also global managers that follow sustainable investment strategies. “Asset managers like Amundi and BlackRock, but also several commercial banks’ treasuries invest in green bonds,” says Tanguy Claquin, head of sustainable banking at Credit Agricole CIB, which ranked as the top arranger of green financing in 2017, according to various league tables. Claquin also sees large potential for growth in the green securitisation market.

Definition
A lack of clarity remains around the definition of green/sustainability. The two phrases are often used interchangeably for investments that have a positive environmental impact.

So far there is no universal agreement on a definition. “Should nuclear energy be considered green? Given the diversity of opinions, it can be challenging to establish ‘standard’ definitions of green,” according to a report on green bonds published last December by The World Bank, Zurich Pension Fund, Amundi Asset Management, and Actiam.

A number of initiatives have been put forth though to set standards. In March, the Loan Market Association launched the Green Loan Principles (GLP) to help growth of the global green loan market. The GLP builds upon the Green Bond Principles (GBP) of the International Capital Market Association (ICMA) and sets voluntary guidelines to promote transparency and disclosure, along with second-party opinions. S&P Global Ratings has the Green Bond Evaluation service, while Moody’s provides the Green Bond Assessment. CBI also provides an extensive taxonomy and certification for green bonds.

global CLO 2While certifications can create extra costs and operational efforts, fund managers like them as they help with due diligence processes to assess a bond’s use of proceeds. “We and our clients want a lot of transparency so that we know how the proceeds are spent, even for future projects that an issuer—at the time of raising a green bond—has not yet selected. We want to make sure we know how the money really is spent,” says Foppe-Jan van der Meij, portfolio manager at Actiam, a €54 billion-plus Netherlands-based fund manager that complies with the Green Bond Principles for investing in green bonds as well as ABS.

The firm‘s investors are insurance companies, pension funds, and wholesale distribution partners like banks. “We are seeing a lot of demand. More and more investors are incorporating green goals and ESG criteria into their strategies. Retail investors are very keen to put money to work towards green bond funds. Returns are in line with non-green bonds, but their [secondary market] performance in a volatile market is more stable,” van der Meij adds.

CBI’s Sean Kidney also notes that while there is growing demand for green bonds, they pay similar spreads to comparable non-green bonds with the same tenor and currency and rating. “Investors don’t do it for the price benefit, they do it for the diversification benefit,” he says.

Asset sourcing
Sourcing enough assets to fill a green fund though is one major challenge for investors, they say, because the number of issuers active in the green bond market is still limited. Actiam said that for its mainstream €3 billion fund, 10% is invested in green bonds, including sovereign and corporates, while the remainder is invested in conventional bonds, although those still need to meet a minimum proprietary ESG score that is better than the benchmark.

White & Case argues this issue can be overcome, saying that there is a critical mass of assets available. “It is just a question of market education and re-examining potentially eligible assets for sustainability,” the law firm wrote in its May client briefing. Moreover, it adds that sustainable securitisations will help free up bank’s balance sheets, enabling them to arrange more deals.

For example, Credit Agricole last year transferred the risk of $3 billion-worth of project finance loans to Mariner Investment via a so-called green capital note (Premium Green 2017-2). As part of the transaction, it committed to use $2 billion of the $3 billion of freed-up capital for new lending in green sectors, such as renewable energy and energy-efficiency loans for commercial real estate and public transportation, among others.

This creates a “sustainable finance loop” that generates more assets on a rolling basis, White & Case says.

Regulatory landscape
The regulatory landscape is also starting to become more supportive of green investment, with a long list of legislative initiatives on the way to help drive investments. For example, under the simple, transparent, and standardised (STS) framework of European securitisation regulation, sponsors and originators will be required from January 2019 forward to disclose information on the energy efficiency of underlying assets in RMBS and auto loan securitisations in order to receive beneficial regulatory capital treatment.

The European Commission has also set up a “High Level Expert Group on Sustainable Finance” to address funding shortfalls and create plans for sustainable finance as part of the European Capital Markets Union. In its action plan published in March, the EC said it would establish a unified EU classification system or taxonomy to define sustainable investments, identify areas where sustainable investments can make the biggest impact, and clarify the duty of asset managers and institutional investors to take sustainability into account in the investment process and enhance disclosure requirements.

On a global level, the Bank of England and the People’s Bank of China as co-chairs of the G20 Sustainable Finance Study Group (SFSG) are currently developing plans to mobilize private capital for green investment, according to SFSG reports. This includes further research into the securitisation of sustainable assets, as approved in a meeting in February. The SFSG will hold its second meeting in early June and then submit a new report to the G20 Finance Ministers and Central Bank Governors Meeting in July and the G20 Leaders’ Summit in December. — Isabell Witt

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US Leveraged Loan Issuers See Earnings Boom

EBITDA growth

New tax policy delivered the expected jolt to bottom-line results in the first quarter, but this was no sugar high for U.S. leveraged loan issuers, as core quarterly earnings growth bulked up to the best result in three years. The rising tide of EBITDA also bolstered key credit metrics, as this protracted credit cycle shows no signs of early-onset weakening in the broad view.

For S&P/LSTA Leveraged Loan Index issuers, EBITDA growth mounted to 9.25% in the first quarter, up from 5% in the fourth quarter and a flattish result in the first quarter last year, according to LCD. Growth in the first quarter was the strongest since readings were 9–10% over the last three quarters of 2014.

The results reflected 12% top-line revenue growth for the quarter, also a high-water result since 2014. The quarterly average from 2015–2017 was roughly four percentage points lower.

The jump in earnings comes at an important time for loan issuers, as LIBOR, the rate on which leveraged loans are based, has been rising steadily since 2017’s first half, from 1.3% last July to 2.33% at the most-recent month-end. That rise in LIBOR means a higher cost of funds for borrowers. That, in turn, could eat into a company’s interest coverage ratio, which indicates a borrower’s ability to service debt.

Interest coverage at the end of 2017 was at 10-year highs, according to LCD, and his remained roughly at that level – despite the significant rise in LIBOR – due to the boost to EBITDA, analysts say. – Staff reports

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US Leveraged Loan Default Rate Dips to 2.12%

US leveraged loan default rate

Despite a fresh default from energy services company Proserv Group, the default rate of the S&P/LSTA Leveraged Loan Index slipped for a second consecutive month, closing out May at 2.12%.

The rate by principal amount is down from 2.37% at the end of April, reflecting the fact that three issuers dropped off the 12-month rolling calculation. Without Proserv, the default rate would be 2.09%.

The default rate has eased from a three-year high of 2.42% in April, but remains significantly higher than the 18-month low of 1.36% at the end of July 2017. – Rachelle Kakouris

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European High Yield Market Struggles through Grim Month of May

europe high yield issuance

May was arguably the most difficult month for the high-yield market in over a year and half, with choppy secondary conditions and rising new-issue pricing resulting in three deal postponements and a drop in volume.

There haven’t been three pulled deals in a month in recent memory, and while a slew of opportunistic borrowers also decided not to launch, such issuance was still the backbone of supply. Nevertheless, while the Italy-induced volatility curtailed supply in May, and might continue to do so until it subsides, a sizable event-driven pipeline continues to build.

This backdrop has been set during a month that started with a flurry of opportunistic activity, but ultimately saw total volume drop to €4.4 billion, down from the bumper months of March and April, when 21 and 29 bonds priced, respectively, for a total of €9.7 billion and €10.5 billion. Encouragingly though, year-to-date volume and deal count are running roughly even with the same period last year. – Taron Wade/Luke Millar

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US Leveraged Loan Issuance Jumps to $66B in May

us loan issuance

Boosted by a surge of opportunistic deals and a spate LBO credits, institutional issuance in the U.S. leveraged loan market has jumped to $66.1 billion in May, the most since the record $78 billion in January 2017, according to LCD.

While institutional activity was up across the board, refinancings returned in a big way, with $24.7 billion of issuance this month, more than double the amount in April and the most since the $33.5 billion in March 2017.

As with refis, institutional recap/dividend volume climbed in May, to $6.6 billion, the most since November and close to double the average during the first four months of the year.

With this month’s surge in activity, overall institutional YTD issuance continues to creep closer to the pace seen in 2017 (last year was a tough act to follow, of course, with a record $503 billion in volume). Through May, loan issuance totals $229 billion, down 11% from the same period in 2017.

Aided by a healthy $14.5 billion this month, YTD LBO loan issuance totals $44.6 billion, slightly ahead of the same period one year ago ($43.9 billion). — Staff reports

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