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US Leveraged Loan Funds See Another Record Withdrawal

leveraged loan funds

U.S loan funds saw yet another record outflow during the week ended Dec. 26, as retail investors withdrew $3.53 billion, according to Lipper weekly reporters.

That’s the sixth straight substantial outflow, totaling a massive $13.5 billion, punctuating a staggering turnaround for the asset class. Before that withdrawal streak, U.S. loan funds and ETFs had seen some $10.3 billion of net inflows. For 2018, then, the final figure will be a net outflow of $3.1 billion, according to Lipper.

The most recent activity brings the four-week trailing average to a $2.6 billion outflow.

Loan funds accounted for $2.9 billion of this week’s outflow, while ETFs accounted for a $626 million outflow. The change due to market value was negative $746 million.

With the withdrawal, loan fund assets have dropped to $90.7 billion, including $9.8 billion from ETFs, says Lipper. — Tim Cross

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Retail Investors Withdraw Record $3.3B from US Leveraged Loan Funds

loan fund flows

U.S. loan funds reported an outflow of $3.29 billion for the week ended Dec. 19, according to Lipper weekly reporters only. This is once again a record outflow for loan funds, easily surpassing last week’s $2.53 billion exit. Prior to that, the next largest outflow was back in August 2011 at negative $2.12 billion.

This is also the fifth consecutive week of withdrawals, totaling roughly $9.9 billion over that span. The four-week trailing average is now $2.05 billion, from negative $1.66 billion last week.

Mutual funds were tapped for a net $3 billion during the observation period, while a comparatively light $298.5 million was pulled from ETFs.

Outflows have now been logged in seven of the last nine weeks and that has taken the year-to-date total inflow to just $406 million, after cresting $11 billion in October.

The change due to market conditions last week was a decrease of $772.7 million, milder than last week’s $1.231 billion drop, which was the largest in four years. Total assets were roughly $95.3 billion at the end of the observation period and ETFs represent about 10% of that, at roughly $10.5 billion. — Jon Hemingway

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US Leveraged Loan Issuance Downshifts in 2018, with $609B in Volume

US volume annual

U.S. leveraged loans have been ensnared in the broad market selloff in the fourth quarter that has likewise pressured the high-yield bond and equity markets.

Retail investors such has loan funds, shifting to risk-off mode, pulled cash from the asset class and left the leveraged loan new-issue machine, which operated largely unfettered in 2018, in a bind. As a result, loans aimed at institutional investors such as CLOs  has totaled $76 billion for the quarter through Dec. 14, according to LCD, the lowest amount since the first quarter of 2016, before interest rates began to rise, kick-starting a long period of dramatic growth for the asset class.

The fourth-quarter number is down 15% from the prior quarter and 46% from 2Q18.

The recent activity leaves 2018 U.S. leveraged loan issuance at $609 billion, taking into account institutional loan issuance and credits syndicated to traditional banks and financial institutions (these deals include amortizing term loans and revolving credits). That’s down from the record $650 billion in 2017, according to LCD.

The institutional loan segment posted $436 billion this year, compared to a record $503 billion last year, according to LCD.

Note: While these numbers are as of Dec. 14, they are not expected to change dramatically between that date and the end of the year proper.

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Leveraged loan funds log record $2.53B outflow

U.S. loan funds reported an outflow of $2.53 billion for the week ended Dec. 12, according to Lipper weekly reporters only. This is the largest weekly outflow on record for loan funds, topping the prior mark of negative $2.12 billion from August 2011.

loan fund flowsThis is also the fourth consecutive week of withdrawals, totaling a whopping $6.63 billion over that span. With that, the four-week trailing average is now deeper in the red than it’s ever been at $1.66 billion, from negative $1.01 billion last week.

Mutual funds were the catalyst in the latest period as investors pulled out a net $1.82 billion, the most since August 2011. Another $704.9 million of outflows from ETFs was the most ever.

Outflows have been logged in six of the last eight weeks and that has taken a big bite out the year-to-date total inflow, which has slumped to $3.7 billion after cresting $11 billion in October.

The change due to market conditions last week was a decrease of $1.231 billion, the largest drop for any week since December 2014. Total assets were roughly $99.3 billion at the end of the observation period and ETFs represent about 11% of that, at roughly $10.9 billion. — Jon Hemingway

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US CLO Issuance Hits Record Volume, Topping $125B

CLO issuance

CLO issuance in the U.S. in 2018 has topped $125 billion, officially eclipsing the all-time record of $124.1 billion set in 2014.

The recent activity raises the total size of the CLO market in the U.S. to $600 billion, according to J.P. Morgan, which projects the market to grow to $700 billion by the end of 2019, after expected net issuance of $100 million next year, taking into account maturing CLOs and loans that are paid down.

To be sure, the CLO market has accelerated in recent years, and following the financial crisis. The total outstanding at the end of 2014 was $350 billion. The pre-crisis peak was $256 billion in September 2008.

Collateralized loan obligation vehicles are an essential component of the U.S. leveraged loan investor base, snapping up roughly 60% of credits offered to institutional investors. – Andrew Park

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US Leveraged Loans Lose 0.22 Yesterday; YTD Return Dips to 2.38%

Daily loan index 2018-12-10

Loans lost 0.22% yesterday after losing 0.16% on Friday, 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 0.38% yesterday.

Loan returns are –0.66% in the month to date and 2.38% in the YTD.

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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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