A great interview, courtesy Bloomberg, with S&P Chief U.S. Economist Beth Ann Bovino on the negative impacts that the growing income disparity in the U.S. is having on economic growth. The complete study is here.
On my annual August West Coast swing I was privileged to have many informative discussions with our friends on the buy-side — including at Los Angeles’ Chavez Ravine, while watching Clayton Kershaw lead the Dodgers to a win over the Angles. What follows is a summary of the insights I was able to glean, which I pass along with as little editorializing as possible.
The buy-side is in the drivers seat
Clearly, managers have adjusted to today’s new normal, in which they are able to control pricing discussions. The reasons are well known. To summarize: Hot money is out of the asset class, for now. Retail flows are negative. High yield accounts are selling. And institutional investors have pulled in their horns for the same reason as have retail investors – a combination of bad press, duration fatigue and the overall risk-off posture of the market.
There’s a broad consensus that terms and conditions are stretched, and debt multiples are pushing into an uncomfortable zone. Will there be another default spike in the years to come, as a result? Of course. Credit cycles have existed since the ancient Sumer civilization supposedly invented debt 3,500 years before Christ.
Given the solid economic outlook, however, an organic catalyst seems like a remote possibility in the near term. That does not dismiss an exogenous shock that sinks the global economy into recession (there are plenty of flash points around today to make such a risk more than idle). But even in that case most issuers can eat out of their own refrigerator, at least for a time, as a result of wide coverage ratios.
Underwriting calendar/CLO warehouses
One big way managers observe that the current period is far different than 2007 is a lack of overhang. Naturally, there is a wide array of CLO warehousing, but warehouse lines are far less vulnerable — from a bank’s perspective — because of large first-loss positions required of equity investors. As well, the underwriting calendar today of roughly $40 billion in M&A loans is a fraction of the roughly $350 billion that loomed over the market – and banks’ liquidity – when the fecal matter hit the rotor device in 2007.
A record year of $100 billion is in the book already, managers say, based on the year-to-Aug. 11 total of roughly $79 billion. The number could go a lot higher — perhaps upwards of $125 billion — given managers’ ability to source sub-par paper in the secondary, and the decent flow of new-issue on tap.
This will remain mostly negative until there’s some meaningful pick-up in rates. That said, 2015 could be a huge year for inflows if the Fed does, as expected, finally start raising rates.
Pension funds and other institutional investors have put the brakes on credit, and what mandates are in process are of the “go-anywhere” variety, that allows managers’ discretion to invest across products and regions.
To sum it up, I’d say for CLO managers these seem to be the best of times. They would not like to see further deterioration that would scare equity investors from the field. But the current state of play is highly conducive to ramping and printing deals (as the volume numbers attest). As for retail managers and those hunting for institutional mandates, it is not the worst of times, by a long shot. But it could be better.
U.S. leveraged loan issuance slid to $5.3 billion last week from more than $20 billion the week prior as institutional investors continued their retreat from all things leveraged finance, forcing a number of borrowers to rework deals or shelve them altogether.
With the week’s activity, year-to-date loan volume totals $392 billion, down from the $408 billion at this point in 2013 (there was a record $605 billion recorded during all of last year).
To be sure, the recent investor withdrawal from the leveraged finance segment – leveraged loans and, even more pronounced, high yield bonds – has thrown the market akilter, including high-profile credits that had been on the horizon.
“Let’s remember, big executions came to market on the idea that issuers could take advantage of hot market conditions, and a summer lull to print deals way in advance of closing,” wrote LCD’s Chris Donnelly late last week. “But it’s not working out like that.”
Indeed, in a high-profile example, Jupiter Resources shelved a $1.125 billion credit backing M&A. As well, SeaStar Solutions scrapped a credit planned to refinance some $208 million in debt while HCP HCP +1.59% Global shelved a $380 million loan backing a dividend to shareholders. Also notable was Charter Communications, which revised a loan backing the company’s acquisition of Comcast assets. – Tim Cross
The CLO markets have definitely not gone fishin’ this month. Last week was the second busiest week of the year globally, with $5.11 billion of volume across nine new CLO transactions. The U.S. priced seven deals, and Europe churned out two more, leaving global volume at $89.86 billion in the year to date, according to LCD. The busiest week globally this year is the week ended June 6, when $7.2 billion of new CLO transactions priced.
Players do not expect more deals to price out of Europe this month. But activity is likely to resume quickly in September, with Carlyle and 3i expected to be among the first out of the blocks, according to market sources. With 15 managers and more working on new deals, the autumn market could be crowded, so managers will want to ensure decent air time among investors by getting deals out promptly.
- US Deal pipeline
- European arbitrage CLO issuance and institutional loan volume
- European Deal pipeline
LCD’s video analysis detailing the European leveraged loan market in July and early August 2014 is now on YouTube.
July was a busy month for the European leveraged loan market. Total volume of new loan issuance hit €14.6 billion, making it the biggest month since July 2007.
July was a breakout month for covenant-lite issuance. By early August, however, there were signs of weakness in secondary markets, particularly on the high-yield side. Arrangers say there is a busy pipeline in the works for September.
If the market is to return in the autumn at the same pace it set in July, it will need to be supported by positive investor sentiment and strong demand for assets.
In this month’s video LCD looks at:
- European Leveraged Loan New-Issue Volume
- Cov-lite Volume
- European Second-Lien Volume
- Average Pro Forma Leverage Ratio
- European Leveraged Loan Volume By Purpose
- European Leveraged Loan Repayments
URL for the slides:
While you’re on YouTube please subscribe to LCD’s YouTube Channel. That way you’ll be certain not to miss any LCD videos. You can also subscribe by clicking on the link to the right of any LCD News email, or here:
If you’d like to embed any LCD video on a web page or in other digital media, it’s simple via the “embed” button on the YouTube page for the video. You can also embed the slides via Slideshare.
The first- and second-lien financing launched to market late last month via Citigroup, Bank of America Merrill Lynch, and BNP Paribas. Commitments were due yesterday.
HCP’s deal is one of a handful of loans to be pulled or postponed amid challenging market conditions in recent days. SeaStar Solutions, Blackboard, and Paradigm all cancelled proposed repricings, while QSRH (Red Rooster) withdrew a planned refinancing. Styrolution, meanwhile, has shelved a cross-border M&A-related transaction.
The HCP transaction included a $50 million, five-year revolver; a $230 million, seven-year first-lien term loan; and a $100 million, eight-year second-lien term loan. The first-lien was originally talked at L+375, with a 1% LIBOR floor, offered at 99. Guidance on the second-lien was L+725-750, with a 1% floor and a 99 OID.
The first-lien loan included 12 months of 101 soft call protection and offered a yield to maturity of 5.02% at original talk. The second-lien loan included 102 and 101 call premiums and offered a yield of 8.7-8.96%.
Proceeds would have been used to refinance existing debt and fund a dividend to shareholders. The Taiwan-based cosmetics-packaging firm was acquired by TPG in 2012.
European CLO issuance in the year to date has reached €7.7 billion following the two recent pricings from ICG and Avoca Capital (subscriber links). This year’s supply has now eclipsed the €7.4 billion issued for the whole of 2013, and puts the market well on track to meet analysts’ full-year supply forecasts of €10-15 billion. – Sarah Husband
It may be August but still the CLO market is still churning out new transactions, with the recent secondary weakness presenting a buying opportunity for managers ramping up deals. Five new deals priced last week in the U.S. for more than $3.5 billion, while Europe broke its five-week drought with a new pricing on Friday. As a result, global volume in the year to date rises to $84.75 billion, according to LCD.
YTD U.S. CLO issuance has topped $74.77 billion from 138 deals, according to LCD, making last year’s $45.64 billion from 94 deals in the same period look meager.
- US arbitrage CLO issuance and institutional loan volume
- European arbitrage CLO issuance and institutional loan volume
- Deal pipeline
After two months with no defaults, two issuers – Essar Steel and Nelson Education – defaulted on $766 million of S&P/LSTA Index loans in July. Despite the uptick in volume, the loan default rate by principal amount eased to 3.89%, from 4.41% in June, as Cengage’s $3.4 billion default from a year ago fell out of the lagging-12-month calculation.
- Lagging-12-month leveraged loan default rate by number
- 2016 maturity wall
- Shadow default rate (excluding EFH)
- Share of performing loans bid at 70 or lower (excluding EFH)
- Share of first-lien loans rated CCC+ or lower (excluding EFH)
- Average leverage of large LBOs
- Share of large LBOs with leverage of more than 7x
- Average (EBITDA)/cash interest of large LBOs
- Cumulative default experience by initial cash-flow-coverage ratio
- Leveraged loan default rate and imputed default rate
Over its 25-year history, the CLO product has been written off as dead, or at the very least hobbled, at least twice: (1) in the wake of the early-2000s default spike, and (2) after the 2008 credit crunch, when the entire structured-finance market came under intense regulatory scrutiny. Over the past 12 months, however, CLO technology has proved resilient yet again, and in fact is thriving like never before. For one thing, the number of managers that printed a new vehicle over the past 12 months increased to 101, from 92 in 2013 and 66 a year earlier. Further, the current figure is within sight of the all-time high of 110, from 2006.
- CLO volume
- CLO market history
- European CLO volume