Has Price Masked Credit Risk In the U.S. Leveraged Loan And

Until recently, pricing on the debt of speculative-grade U.S. corporate borrowers has painted an improving picture of credit risk. However, in Standard & Poor’s view, credit quality for some highly leveraged companies remains fragile. Why? In this CreditMatters TV segment, Bill Chew, head of our recovery team and leveraged finance group, provides an in-depth look at the positive and negative trends shaping the space.

Hello and welcome to this edition of credit matters tv i’m greg loomis teen and today we will talk about pricing and credit risk i’m here with bill chu who was head of our recovery ratings team and leveraged finance group and bill we published a commentary recently called is pricing masking credit risk earlier this month can you tell us what you mean by masking

Well when we refer to a pricing masking credit risk we’re basically saying is simply that the pricing recovery in the leverage space has been very very strong and with there’s no question about that at least until the last couple of weeks when we’ve really seen some backup and pricing both the primary and secondary markets but while that’s been happening our credit

Ratings have tracked real fundamental improvement in credit strength but not in most cases at the level of the recovery and pricing and the ratings also stress that we that these issuers continue the speculative grade leveraged issuers continue to face important credit risks what is that some piece of view of credit risk well i think we see it in two basic elements

Of credit risk first what we termed the default risk that’s the principal risk measured by the issuer credit ratings the entity ratings that we assigned each company that’s issuing debt in markets and if you look at those issuer credit ratings they show improvements there’s no question about it the rating changes have become much more positive for the first time

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In years we’ve actually seen more rating upgrades and downgrades even through the current quarter although that’s beginning to level off with the you know a number of upgrades beginning to be much closer to the number of downgrades the credit outlooks have also shown an important improvement these are the books or our near-term indicator of what the near term

Trend is going to be on the rating typically at one year horizon for speculative-grade credits negative outlooks now are down to about sixteen percent of outlooks and that’s down sharply from thirty percent out books that we had in mid oh nine at the depths of the crisis so clearly improvement in the credit profile the actual trend on on default actual defaults

Also has been very positive peak default rates peaked at over eleven percent were down down on the on the current numbers to about two and a half percent per issue default rates and our global fixed income research groups forecast for march of 2012 is about 1.6 so this is sharply down from the peaks and down from the average of four point five percent so it’s a

Positive story overall on the trend the point that we keep making is with these improvements we still have a lot of risk that leveraged issuers continue to face in the us market and does touch on a couple of these first the credit mix is very weak forty-seven percent of sp rated issuers are now in the lowest two rating categories single bein triple c this is the

Lowest run wrong even amongst leverage credits contain nearly half of all rated issuers at a pone snp’s rated portfolio and in addition we see that that there is a potential that we will see a return on refinancing risk as an issue refinancing was not an issue in 2010 and most of 2011 because we had a robust refinancing market at work with ready access for most

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Issuers of any credit quality whatsoever and except there were some challenges that the most low lowly rated issuers but most issuers were able to get an extension of their maturities and refinance out that’s changed at least because of two factors first that we clearly see a much less liquid market right now last couple of months of seen a real outflows from both

Leveraged loans and high-yield bonds segments of the market and we look out into the future and we see now on the horizon in 20 2013 at the 16 a large block of maturities that needs to be refinanced we estimated sp that us issuers will have to fit a refinance at least a billion dollars of maturities in that period the final thing is that we see a real weakness

In revenue growth median revenue growth for the 150 must liquid names in the ls da index is about mid single-digits both on sequential and your quarter over prior year’s quarter basis so we have yet to see strong revenue growth and we’re now seeing rising costs so we may really see margin squeezes on some of these companies especially the leveraged companies that

Don’t have the pricing power to pass through those cost increases right so turning to from default risk to recovery yeah although on the recovery side we’ve seen the same pattern we that we’ve observed in other credit cycles when we have and it sharp improvement in the default rate we also get an improvement in recovery rates and that’s happened this time as well

The recovery rates in last two years are sharply above the the rates that we have seen in previous periods when we turn and turn beyond the actual experience out again looking at the forecast though we see a somewhat more challenged situation we forecast we are estimates of future recovery rates come in the form of our recovery ratings which are issued on a one

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Through six scale strongest recovery being one lowest recovery being a six and when we compare the recoveries that are implied in those ratings with the actual recoveries that we’re observing in both on an annual basis and in the overall database that we use from 1988 through the present it collects all historical recoveries we can find we see that the recovery

Rates for each of the principal classes of debt in our recovery ratings is below what we see me and the historical they do sharply below the recent numbers which we know are high but also below the the averages the long-term averages that are in there in the law stats database so finally we’ve seen a lot of volatility in the markets the last few weeks a lot of cute

Political risk a lot of economic news as anything recently changed our view either on default risk or recovery analysis know if anything i think we would reinforce it reinforce the views that i’ve just been talking about that while we’ve seen a recovery in the market pricing of risk a very strong recovery in the market pricing of risk that the fundamental analysis

Of credit risk expressed in our ratings shows that there still is significant significant risk remaining especially for leveraged issuers in the u.s. it doesn’t mean necessarily that we’re going to see immediate deterioration but it does mean that there are remaining challenges that each of these companies must face okay well thank you for your insights bill and

Thank you for joining us for this edition of credit matters tv you you

Transcribed from video
Has Price Masked Credit Risk In the U.S. Leveraged Loan And By S\u0026P Global Ratings