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PetSmart Downgraded to CCC due to Likelihood of Debt Exchange

S&P Global Ratings has downgraded PetSmart to CCC, from CCC+, citing an increased likelihood of the company pursuing a debt exchange over the next 12 months that would be viewed as distressed.

“Although the company does not have any meaningful near-term maturities and liquidity is likely to remain adequate, we think PetSmart’s capital structure is unsustainable given the continued weak results at its brick-and-mortar retail stores and operating losses at Chewy,” analyst Andy Sookram said in the report.

S&P revised its recovery rating on the company’s $4.3 billion first-lien term loan and its $1.35 billion of senior secured notes to 4, from 3, to reflect the release of Chewy.com as a guarantor under the term loan and the senior secured notes.

This allows the unsecured noteholders to share any residual value of Chewy.com on a pari passu basis with any deficiency claims of secured term lenders and noteholders. S&P also revised the recovery rating on the company’s

 

$1.9 billion of senior unsecured notes due 2023 and its $650 million of senior unsecured notes due 2025 to 5, from 6, reflecting its view of improved access to value that unsecured creditors have at Chewy.com pursuant to the release of the guaranty. (See “PetSmart unsecured bonds rally on Chewy spin-off news,” LCD News, June 4, 2018. $)

Chewy.com still guarantees and provides collateral to the ABL lenders.

Phoenix-based PetSmart faces significant headwinds in its strategy to turn around operations, which have been hurt by heightened competition from other online retailers, regional pet supply stores, and mass channel operators.

S&P sees a greater probability of a debt exchange or restructuring following the recent dividend to parent Argos Holdings that represents 20% of Chewy.com’s outstanding common stock. As a result, PetSmart’s ownership of Chewy.com has been reduced to 80%. This transaction could facilitate a potential separation of Chewy.com from PetSmart’s consolidated operations, which could occur either through additional dividends to the parent company, a potential sale, or a combination of these alternatives.

Following an EBITDA drop of about 30% for the last twelve months ended April 29, S&P views PetSmart’s capital structure as unsustainable given its forecast for continued EBITDA declines. The company’s $750 million asset-based revolver remained undrawn, with cash on hand at $331 million against debt of $8 billion. — Rachelle Kakouris

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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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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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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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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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With Defaults Low and Oil Prices Rising, Distressed Debt Continues to Disappear

Thanks to a decade-long stretch of low interest rates, which has made it easier for troubled companies to kick the debt can further down the road, the already-scant opportunity for funds looking to buy up paper at distressed levels continues to shrink.

A seventh consecutive decline in the U.S. distress ratio has pushed the share of bonds trading in excess of 1,000 bps over the risk-free Treasury rate—the common measure of distress—to its lowest level in 3.5 years. At just 5.2%, it is significantly below the post-crisis high of 33.9% from February 2016, according to S&P Global Fixed Income Research.

In dollar terms, that equates to just $48 billion, merely a hair’s breadth from the near-four year low of $46 billion reached last month, and just 15% of the February 2016 high of $328 billion.

The dearth of opportunities is even more stark in leveraged loans, where the share of performing loans in the S&P/LSTA Leveraged Loan Index trading below 70 cents on the dollar (a level normally associated with deep distress and significantly high default risk) fell to just 0.56% as of May 30, the lowest it has been since December 2014. –

us loan distress ratio

One area where this is distress, of course, is retail, where the rate recently hit 24%, and in cosmetics/toiletries (32%, though that’s entirely driven by one loan issuer: Revlon). Both of these numbers are post-crisis highs, according to LCD.

While those numbers are eye-catching, the retail segment does not constitute a significant segment of outstanding leveraged loans, so the amount of paper involved is not large. – Rachelle Kakouris

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Leveraged Loans – Amid Continued Investor Demand, Second-Lien Issuance Surges

US second lien

The leveraged loan markets in both the U.S. and Europe have seen a boost in the issuance of second-lien activity as institutional investors and retail loan funds (in the U.S.) continue their hunt for higher-yielding paper.

As the name implies, second-lien loans reside lower in a deal’s capital structure, meaning they are repaid after the more-senior tranches (the first-lien debt). Consequently, they are inherently more risky, and therefore are more richly priced.

In May, Second-lien issuance in the U.S. leveraged loan market surged to its highest level in eight months, to more than $3 billion.

Europe second lien

In Europe, second-lien loans are rapidly becoming European private equity shops’ favored choice when adding a subordinated layer of debt to buyout financings, and to boost leverage. This activity has hit post-crisis highs, as the deep demand for paper threatens to push out high-yield bonds from all but the largest capital structures.

Indeed, the resurgence in second-lien is changing the very make-up of Europe’s buyout market. For the first time in the post-crisis era, the portion of buyouts taken by first lien-only structures has fallen below 50% this year, to 45% of deals, according to LCD. First lien-only structures were last year responsible for 61% of buyout transactions, and 75% in 2016. – Staff reports

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