M&A Takes Charge in Europe’s Leveraged Loan Market

european loan volume

M&A activity is driving issuance in the European leveraged loan segment so far in 2018.

So far this year there have been €8 billion in loans backing leveraged buyouts launched to the syndications market, along with €9 billion supporting other M&A. That total, €17 billion, makes up the lion’s share of the €27.4 billion in overall issuance, according to LCD.

And although the market has clearly seen the return of big deals, such as those for ProSieben (€7.3 billion), Wind Telecomunicazioni (€7.2 billion), and TDC A/S (€7.2 billion), M&A-related volume is not only comprised of the headline transactions.

Indeed, this year has seen a steady stream of smaller-scale buyout and acquisitions, along with secondary buyouts. These include the buyouts of Flamingo with a term loan of €280 million, the €195 million TLB backing Cinven’s buyout of Planasa, and Equistone Partners’ sale of E. Winkemann to Cathay Capital Private Equity.

Buy and build has also been a feature of the market, with Nordic Capital’s acquisition of three dental chains in the Netherlands, Switzerland, and Germany, and the €375 million total financing backing Ardian’s buyouts of Spanish bread and bakery companies Berlys and Bellsola. – Taron Wade

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Fridson: High Yield Bond Prices Less Volatile than Math Suggests. Are the Dice Loaded?

Certain things can be proven statistically, even if the cause is unknown.

Consider what happens when your roll a pair of dice. There are 36 possible combinations, e.g., (1 + 1), (3 + 4), (6 + 5). Only one combination—(1 + 1)—produces an outcome of 2. Therefore, you can expect to roll a 2 only one out of 36 times, on average. On the other hand, six combinations produce an outcome of 7— (1 + 6), (2 + 5), (3 + 4), (4 +3), (5 + 2), (6 + 1). Accordingly, you can expect to roll a 7 once in every six rolls, on average. The table below shows the number of times each outcome should occur in 100,000 rolls.

Fridson Monthly 2018-02-28 table 1a

If the results of your dice-rolling experiment diverge from these figures by more than a tiny, tiny bit you can be certain that you were not using fair dice. (We rule out the possibility of psychokinesis.) Note as well that the results do not tell you why the dice were not fair. There may have been a defect in the manufacturing process. Alternatively, someone may have “fixed” the dice by loading, shaving, or some other method. Whatever the cause, the fact that the dice are not fair is incontrovertible, given the laws of probability and the very large number of trials.
Let us now consider price moves on bonds. Unless something unusual is going on, a histogram of monthly price changes should produce a bell-shaped curve as in the illustration (non-bond-related) below (see note 1). This pattern is intuitive to seasoned market participants: In most months, prices go up or down by about an average amount. Once in a while the price change is much greater or much smaller than average. Even more infrequently the monthly price change is very much greater or smaller than average. (By the way, this same reasoning applies to total returns. We confirmed that our key result holds for total returns as well as price changes.)

The notion that price moves should follow a normal distribution is not a matter of academic theorizing with no connection to the real world. According to the math that formally describes the bell-shaped curve, price changes in 68.2% of all months in the sample of observations should fall in a range of plus/minus one standard deviation from the mean (simple average) return. Price changes between one and two standard deviations greater than the mean or between one and two standard deviations smaller than the mean should account for 27.2% of the months. That leaves 4.6% of all months in which to expect price moves more than two standard deviations above or below the mean. In the top panel of the table below, we apply those percentages to the 372 months in our 1987–2017 observation period to predict how many months will be found in each of those three ranges, if the monthly price changes are in fact normally distributed.

In the case of investment-grade corporates, the actual distribution among the three ranges almost perfectly matches the predicted distribution—253/101/18 versus 254/101/17. That result should lay to rest any notion that the normal distribution is just a theoretical model of how the things would work in an idealized world. Investment-grade corporate behavior demonstrates that following a bell-shaped curve with a specific mathematical description is how the real world works.

Government bonds (Treasuries and agencies) veer a bit more from the predicted distribution. All told, 125 months lie outside the range of plus/minus one standard deviation versus the predicted total of 118. Note that research has found that sort of pattern in equity returns, popularly referred to “fat tails.” That abnormality is commonly attributed to momentum trading. The notion is that instead of settling down to normal swings after major positive or negative news comes into the market, stocks continue to gyrate wildly without any additional, major news hitting the market, thanks to aggressive traders who jump on the recent trend and overpower value-oriented traders.

High-yield bonds display the opposite sort of abnormality. Instead of having too many extreme moves, the asset class has too few. Prices in just 83 months moved up or down by one standard deviation or more, some 30% less than the predicted count of 118. The “missing” months were all in the plus/minus 1–2 standard deviations range—just 64 actual versus 101 predicted. Extreme observations of plus/minus 2 standard deviations or more were about right—19 actual versus 17 predicted.

These are not inconsequential divergences from the standard bell curve. With the statistical technique known as the Jarque-Bera(JB) test we can confirm that the data shown for the ICE BAML High Yield Index do not represent a normal distribution. The calculation produces a very high JB value indicative of non-normality and a p-value far below 0.01. Similarly non-normal are the distributions shown, in the second panel of the table, for the BB, B, and CCC-C sub-indexes. Of the three, the BB sub-index is the most overconcentrated in the plus/minus 1 standard deviation range—202 actual months versus 172 predicted.

Why are high-yield price moves not normally distributed?
If a dice-rolling experiment fails to produce the predicted distribution of outcomes, as discussed above, we know that the dice are not fair. That information does not explain why the dice are not fair, that is, whether the manufacturing process was defective or whether somebody altered them. Similarly, the fact that price changes on the high-yield index are not normally distributed does not tell us why they are not normally distributed. We can, however, generate hypotheses and, to the extent feasible, test them.

One hypothesis we thought of is that the Federal Reserve has created an artificially stable financial environment through its quantitative easing (QE) policy. The third and fourth panels of the table display the results of our test of this hypothesis. They show far fewer months outside the plus/minus one standard deviation range in both the pre-QE era (42 actual versus 84 predicted) and the QE era (25 actual versus 35 predicted). The JB test confirms that in both sub-periods the distributions are non-normal. In short, we can reject the hypothesis that quantitative easing artificially stabilized the high-yield market, resulting in fewer extreme monthly price changes than ought to have been observed. If anything, high-yield price changes have been closer to normal during the QE period. (Note that the pre-QE versus QE testing is based on means and standard deviations within those sub-periods.)

We have come up with only one other hypothesis to explain the shortfall of extreme price changes in the high-yield market. Other market participants may find it unpalatable and propose other possible explanations. We encourage discussion and debate on this topic.

Our remaining hypothesis is that reported prices understate the high-yield market’s true volatility. This does not necessarily imply that traders are deliberately understating the magnitude of price declines during major market declines, although we cannot readily disprove that possibility.

Understatement of price declines could also result from good-faith efforts to mark to market the many issues that do not trade in any given month.
Note that if price declines are understated in downturns, price rises will be understated in subsequent upturns. This can explain why in the underlying data we find a shortfall of large up moves as well as a shortfall of large down moves. Also, as noted above, the shortfall of extreme high-yield price changes was entirely in the plus/minus 1 to 2 standard deviations range. We might reasonably infer that the flaw in high-yield pricing, whatever it turns out to be, understates price changes in “somewhat extreme” market declines, but cannot hide the most massive sell-offs.

Our finding of a non-normal distribution of high-yield price changes, with fewer extreme changes than are expected to occur in a properly functioning market, has important implications for asset allocation. It implies that the index-derived standard deviations and, by extension, Sharpe ratios that institutional investors are using to evaluate the high-yield asset class paint too rosy a picture of its risk-reward ratio. Further exploration of this important question seems warranted.

Indexes used in this report:
ICE BofA Merrill Lynch BB US High Yield Index
ICE BofA Merrill Lynch B US High Yield Index
ICE BofA Merrill Lynch CCC-C US High Yield Index
ICE BofA Merrill Lynch US Corporate Index
ICE BofA Merrill Lynch US High Yield Index
ICE BofA Merrill Lynch US Treasury & Agency Index

Thanks to John Finnerty and Yuewu Xu for their kind assistance in this analysis. Any errors or omissions are the author’s.

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Marty Fridson, Chief Investment Officer of Lehmann Livian Fridson Advisors LLC, is a contributing analyst to S&P Global Market Intelligence. His weekly leveraged finance commentary appears exclusively on LCD, an offering of S&P Global Market Intelligence. Marty can be reached at [email protected]

Research assistance provided by Kai Zhao and Yaxian Li.

ICE BofAML Index System data is used by permission. Copyright © 2018 ICE Data Services. The use of the above in no way implies that ICE Data Services or any of its affiliates endorses the views or interpretation or the use of such information or acts as any endorsement of Lehmann, Livian, Fridson Advisors, LLC’s use of such information. The information is provided “as is” and none of ICE Data Services or any of its affiliates warrants the accuracy or completeness of the information.


US Leveraged Loan Default Rate Hits 3-Year High, Courtesy iHeart

The default rate of the S&P/LSTA Leveraged Loan Index jumped to its highest level in three years after iHeartMedia, one of the largest highly levered remnants still standing from the LBO boom, filed for Chapter 11 bankruptcy protection.

The radio giant’s highly anticipated filing included $6.3 billion of Clear Channel term loans, propelling the rate to 2.42%, from 1.7% previously, and marking the fifth largest default in the history of the Leveraged Loan Index.

iHeart default chart 1Though significantly higher than the 18-month low of 1.36% where it stood the end of July 2017, the current rate still remains well inside the 3.1% historical average.

By number of issuers, the default rate is now 1.93%, from 1.94% at the end of February.

As the table below shows, all but one of the 10 largest S&P/LSTA Index defaults on record were products of the 2006/2007 credit boom, or in the case of Energy Future Holdings and Caesars, the resultant LBO boom.

For iHeart’s part, the media giant, formerly known as Clear Channel, filed for Chapter 11 in bankruptcy court in Houston after more than a year of negotiations with its creditors with an agreement in principle to cut its $20 billion debt load by half.

According to a Form 8-K filed with the Securities and Exchange Commission, the company said it expects to formally enter into a restructuring support agreement “in short order.” Court filings show an early challenge from the legacy, pre-LBO noteholder group, is expected to the proposed restructuring deal. (See “iHeart files Chapter 11, sees challenge from legacy noteholder group,” LCD News, March 15, 2018).

As with almost all of its $20 billion debt pile, Clear Channel’s $5 billion D term loan due 2019 (L+675) and $1.3 billion E term loan (L+750) were put in place as part of the company’s 2008 buyout by Bain Capital and Thomas Lee Partners, and extended in 2013.

Finally, following iHeart’s bankruptcy filing, the default rate within the broadcast radio and television sector jumped to 33.59% by amount, from 7.23% previously.

For context, Ocean Rig and Answers Corp. rolling off the calculation has partially offset the impact of iHeart’s default, with the default rate falling from 2% at the end of February, to 1.60% at the beginning of this month upon the removal of the two issuers, and prior to this month’s defaults from iHeartMedia and Harvey Gulf. — Rachelle Kakouris

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10 Years After the Credit Crisis – A Free Event From LCD and S&P Global Market Intelligence

interest coverage
LCD and S&P Global Market Intelligence are pleased to present an in-depth look at how today’s leveraged finance market compares to that of 2007–08, before the onset of the credit crisis.

This complimentary, in-person event will feature analysis from high-yield bond market expert Martin Fridson and LCD’s Marina Lukatsky, as well as a discussion on the state of today’s market, featuring Crescent Capital Managing Director Jonathan Insull, LSTA Executive Director Lee Shaiman, Progow Executive Chairman Peter Gleysteen, and LCD Senior Editor/CLO market reporter Andrew Park. The panel will be moderated by LCD Managing Director Ruth Yang.

This event will be held at S&P Global U.S. headquarters at 55 Water Street in Manhattan on March 27, at 4 pm EDT, and will be followed by a cocktail reception. Space is limited so kindly register by March 20.

More info about the event and a link to register is here.


Community Health Eyes Uptier Debt Swap, Leveraged Loan Amendment

Community Health Systems disclosed in a presentation to lenders today that it plans to address its most pressing debt maturities with an uptier exchange. The company added that once the exchange and announced term loan amendment —  which among other things seeks to increase its junior secured debt capacity —  are completed, it will then seek to extend or refinance its $1 billion term loan G coming due in 2019.

The hospital operator also revealed it has retained Citi, Credit Suisse, JP Morgan, and Lazard as financial advisors. As reported ($), Community Health’s near-term bonds sold off by as much as 4.75 points after news circulated yesterday of the Lazard hire.

The company’s $1.2 billion issue of 7.125% notes due 2020 and its $1.925 billion issue of 8% unsecured notes due November 2019, which becomes current this November, slumped anew in active trading this morning, falling 3.5 points, to 78.5, and four points, to 88, respectively. Community Health’s G term loan due 2019 was down about an eighth a point this morning, at 98.375/99.

The company last month amended its credit facility to remove an EBITDA to interest ratio covenant and replace a senior secured net leverage covenant with a first-lien net leverage covenant, and also to reduce revolving commitments to $650 million, from $840 million. Sources at the time noted that the company’s shift to a first-lien net leverage covenant raised eyebrows about whether the issuer is attempting to open the door to a refinancing or an exchange offer into second-lien debt.

S&P Global Ratings yesterday downgraded Community Health’s corporate credit rating to CCC+, from B–, citing weaker than expected cash flow guidance for 2018 and refinancing concerns in light of the large debt maturities the company needs to manage over the next few years.

“We believe refinancing risk is elevated, particularly given the company’s significant ongoing transformation efforts,” analyst David Peknay said in the ratings report.

Community Health Systems is a Franklin, Tenn.–based operator of general acute-care hospitals and outpatient facilities in communities across the U.S. — Rachelle Kakouris/James Passeri

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Hi-Grade: McDonald’s launches $1.5B Bond Offering into Heavy, Post-CVS Market

mcdonaldsWhile tough marketing conditions this week have sidelined many prospective issuers, McDonald’s Corp. today launched a $1.5 billion, three-part offering, after inking a similar structure one year ago. The new offering was split evenly across $500 million each of five-year notes due April 1, 2023 at T+75, 10-year notes due April 1, 2028 at T+100, and a tap of the existing 4.45% notes due March 1, 2047 at T+140, sources said. Launch levels imply reoffer yields of roughly 3.35%, 3.81%, and 4.46%, respectively.

McDonald’s launched the deal at the firm end of guidance (which was set in the areas, plus or minus five basis points, of T+80, T+105 and T+145), and 15–20 bps through early whispers. Even so, McDonald’s appears on track to pay 5–10 bps of new-issue concession to clear today’s offering in heavy markets.

The 4.45% 2047 tap is projected to be placed at a yield close to the coupon rate. The deal was originally printed in March 2017 as a $550 million offering at T+137, or 4.48%. The issue traded earlier today at a G-spread of 142 bps, or roughly 10 bps higher than levels on Monday, according to MarketAxess.

That 30-year tranche was part of a $2 billion, three-part deal that also included 2.625% five-year notes due January 2022 at T+62, or 2.639%, and 3.5% 10-year notes due March 2027 at T+107, or 3.562%. For reference, the 2022 issue changed hands this morning G-spreads from 58–60 bps, before accounting for roughly six basis points on the curve, and the 2027 notes traded last week at G-spreads in the area of 86 bps, and roughly three basis points wider today, trade data show.

Cautious marketing of the new bonds follows on a staggering $64.2 billion of high-grade offerings placed over the five sessions through Monday, including big M&A deals inked by CVS Health last Tuesday ($40 billion, or the third largest corporate offering on record) and Campbell Soup on Monday ($5.3 billion). That rolling sum was less than $5 billion shy of the of the all-time record for any five-day period, or the $68.8 billion placed in the five sessions around a $46 billion M&A-driven behemoth inked by Anheuser-Bush InBev in January 2016, according to LCD.

At the tail end of the latest issuance deluge, borrowers on Monday paid roughly 12 bps in new-issue concessions, on average, rivaling the extra costs witnessed in the immediate aftermath of the shock Brexit vote in June 2016.

Proceeds from today’s offering will be used for general corporate purposes. Of note, the company has $750 million of 2.1% notes coming due on Dec. 7, 2018, followed by $400 million of 5% notes due in February 2019, according to S&P Global Market Intelligence.

In March 2017, the company announced that it would return $22–24 billion of cash to shareholders through 2019. Last July, it announced a new $15 billion share-repurchase program, which does not have a specified expiration date. McDonald’s in 2016 completed an accelerated share-repurchase program and bought back a total of $11.2 billion of its shares over the calendar year. That was up from $6.1 billion in 2015, and is by far the most in the company’s history, according to S&P Global Market Intelligence. Buybacks in 2017 amounted to $4.7 billion.

The Oak Brook, Ill.–based restaurant company’s ratings profile includes stable outlooks on all sides.

In December 2017, Fitch affirmed its BBB rating on the company. “McDonald’s ratings balance its shareholder-friendly financial strategy with its substantial cash flow, significant scale, improved comparable sales (comps), and Fitch’s view that the company will maintain total adjusted debt/EBITDAR in the mid-to-high 3.0x range while generating FCF of about $1 billion or more annually,” analysts said.

S&P Global Ratings maintains a BBB+ rating for the company. “We also believe McDonald’s will moderate share repurchases over the longer term while continuing to work to return revenue growth and customer traffic. We assume the company will maintain leverage of less than 4x, supported by the range of initiatives that began in 2015. Still, the competitive environment is fierce for the quick service restaurant sector overall,” the agency said in ratings rationale published in April 2017. — Gayatri Iyer/ John Atkins

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