Leveraged Finance Market Is Not Overheated — Yet

Issuance in the European leveraged finance market is booming for both high-yield bonds and loans, driven in part by a renaissance of the collateralized loan obligation (CLO) market. In this edition of Inside Credit, Standard & Poor’s credit analysts Taron Wade, David Gillmor and Matthew Jones discuss these issuance trends, the new vintage of CLOs and dividend recapitalizations.

The leveraged loan and high-yield bond markets have had an impressive year so far in terms of both number and the value of transactions on this edition of inside credit we examine the drivers behind this activity as well as the impact on credit quality european high-yield bond issuance has already smashed the 40 4.4 billion euro record from 2010 at fifty four point

Eight billion to the end of the third quarter and on the loan side in the same time period issuance has once again reached 2008 levels we can see from the chart just how much the use of instruments has changed as well since 2006 and 2007 and how much lower the percentage of debt used for leveraged buyout transactions has fallen i’m joined today by david gilmour

And analytical manager in the european leveraged finance team and matt jones analytical manager in our structured finance group welcome thank you so david can you start us off by talking about this shift that we’ve seen from lbo financings to non lbo financings for both asset classes and why that why it is we’ve been seeing that absolutely well there are two main

Reasons the first is the increase in fallen angels i those credits which used to be investment grade which are not bb+ and below so they increased doubled in terms of volume in 2012 and change 2013 such one of the reasons for the non sponsor own dell bios increasing also it’s worth mentioning that they tend to be larger companies so x value they will be larger and

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The second reason is very simply that non sponsor ohms corporates are just getting christie comfortable with their with leverage and so they’re back there perfectly they realize that liquidity is there for bb single credits so they’re just happy to be more levered okay and we see this increasing this trend absolutely i mean it seems to be not going to end now matt

One of the reasons that we’ve seen an increase in the volume of loan transactions is because of the increase in cielo funds are the inflow into cielo funds can you just give us a sense of why that’s happening and also with the differences between the new cl of funds compared to the old vintage hiren well this year we’ve seen just over 6 billion of euro issuance

In euro cielo or euro cielo 2.0 which we refer to as any transactions which you’ve closed in 2013 but pretty much post-crisis that’s from approximately 17 transactions from 13 or 14 managers of a base of virtually zero since 2008 in terms of why that’s happened this year i mean towards the end of last year and beginning of this year we saw a return to arbitrage

Conditions and what i mean by that is that the the senior liability spreads that investors are willing to take in these structures and combined with the the asset spreads on the underlying collateral of meant that equity returns for for equity investors within the structures have have been have been commensurate with our expectations as well as that we’ve seen them

Very strong performance from cl 0 1 point 0 transactions or pre-crisis transactions that we published a report earlier on this year which looked at more structured finance asset classes in europe at since 2007 and with the exception of one technical default you know euro clo leveraged loan structures have actually had a 0% default rate and combined with the the

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Performance more recently of these structures we seen a significant level of upgrades as structural to leveraging and stable asset performance as increased credit enhancement in terms of how the new structures are different to the previous ones i mean in terms of the assets that they’re broadly broadly the same but we’ve also we have seen high levels of credit

Enhancement driven in part by rating agency criteria we see shorter weighted average lives and we’ve also seen repricing mechanisms brought into these structures which gives equity holders call options if they can reprise further down the line although perhaps more telling that we’ve seen fewer fewer transactions later on a year include these structures as part of

Triple-a investors are pushing back against a feature they’re not particularly particularly happy with one or two transactions have also had sort of more novel features such as fixed-rate buckets which reflect the managers flexibility or need for flexibility around on a ramp up the period ramp up assets during the period with with fixed-rate bonds and on the low

On the balance sheet side we’ve we’ve seen fixed-rate assets and we’ve also seen of quarterly pay transactions and we’ve also seen one or two multi currency transactions so david let’s talk again about more specifically on the transaction side we have seen an increase in dividend recapitalizations and they can often indicate that credit conditions are getting more

Aggressive what do we think about that it’s a good question we’ve seen about seven billion of debris cups in europe for the first nine months this year that compares with two billion euros for the first nine months of last year so absolutely a huge increase i divide between the senior dividend recap senior that recap and the subordinated debt recap interestingly

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Enough if you look at the upgrades and downgrades or more importantly the downgrades we’ve seen very very few downgrades based upon dividend recaps i think we’ve seen one in the first half and one in the second half this year the reason it been so few is that it so far it has tended to be in the very good very well performing companies that undertaken these recaps

So you’ve got the two offsetting factors of company performing well or ahead of expectations generating good cash against the increased leverage in the cap structure so net-net we’ve not been done grading very many of the companies for a standard dividend recap so not an obvious indication of sort of excess frosting us in the market slightly more interesting on

The subordinated dividend recaps in particular to pick toggles we’ve seen a decent volume of pik toggle through the year and so for those in pretty much every case we’ve allocated recovery rating of six which means we expect recovery of zero to ten percent and those instruments so obviously we need to look at probability of default as well but essentially if the

Company does default we think you’re going to get negligible recoveries and the question i would ask is the pricing of noses after about ten or eleven percent the investors need to be very clear that their their view of the risk and probability of default is enough to balance the total loss of their of their monies okay great well thanks both for joining us today

That concludes this edition of inside credit thanks for joining us you you

Transcribed from video
Leveraged Finance Market Is Not Overheated — Yet By S\u0026P Global Ratings