The U.S. Leveraged Loan Market Today s drivers, tomorrow s challenges. Meredith Coffey, LSTA mcoffey@lsta.org

Transcription

1 The U.S. Leveraged Loan Market Today s drivers, tomorrow s challenges Meredith Coffey, LSTA mcoffey@lsta.org

2 Presentation Overview Today s Leveraged Loan Market Tomorrow s Regulatory Environment What Might Happen When They Meet 2

3 Today s Market 3

4 Fed Asset ($Bils.) Setting the Stage: Federal Reserve buys assets And investors seek yield (and assets) elsewhere 4 Federal Reserve Balance Sheet Source: Federal Reserve 4

5 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Jan 27 May 27 Sep 27 Jan 28 May 28 Sep 28 Jan 29 May 29 Sep 29 Jan 21 May 21 Sep 21 Jan 211 May 211 Sep 211 Jan 212 May-12 Sep-12 Jan-13 May-13 Sep-13 Loan fund flows ($Bils.) Loan Mutual Fund AUM ($Bils.) Money flows into loan mutual funds and AUM Climbs Loan Mutual Fund Monthly Flows Loan Mutual Fund AUM Source: Thomson Reuters LPC 5

6 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 CLO Issuance ($Bils.) CLO issuance climbs (but CLO AUM not moving as much) Monthly CLO issuance CLO AUM CLO 1. CLO Jun- 11 Sep- 11 Dec- 11 Mar- 12 Jun- 12 Sep- 12 Dec- 12 Mar- 13 Jun- 13 Sep- 13 Source: Thomson Reuters LPC, Citi 6

7 1Q7 2Q7 3Q7 4Q7 1Q8 2Q8 3Q8 4Q8 1Q9 2Q9 3Q9 4Q9 1Q1 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 Iss. ($Bils.) Outs. ($Bils) Institutional outstandings climb past Pre-Crisis levels Institutional Issuance vs. Outstandings Inst Loan Issuance Inst Loan Outstandings Source: S&P/LCD, S&P/LSTA Leveraged Loan Index 7

8 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Amount ($Bils.) Visible demand outstrips supply by nearly $5 billion Institutional Issuance vs. Outstandings Cumulative CLO/mutual fund demand Cumulative change in outstandings Source: S&P/LCD, S&P/LSTA Leveraged Loan Index 8

9 Impact on terms & conditions 9

10 Jan-6 Apr-6 Jul-6 Oct-6 Jan-7 Apr-7 Jul-7 Oct-7 Jan-8 Apr-8 Jul-8 Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Amount ($Bils) Share (%) There are more covenant lite institutional term loans Covenant lite loan volume/share in the S&P/LSTA Leveraged Loan Index 65 1% Cov-lite vol Cov-lite share 8% 6% % % 5 % Covenant lite loan issuance now comprises half of new issue institutional loans and 4% of outstanding loans These loans do not have maintenance covenants, but do have incurrence covenants Covenant lite loans returned because they performed well: Lower default incidence and higher recovery given default in the crisis Source: S&P/LSTA Leveraged Loan Index 1

11 Q-3Q Q-3Q13 Ratio (x:1) Ratio (x:1) New issue loans: Metrics are more bullish But not at 27 levels New Issue Debt/EBITDA Multiples New Issue Interest Coverage Ratio Debt/EBITDA of LC Lev Cos Debt/EBITDA of LC LBOs While debt/ebitda multiples are climbing, coverage ratios are very strong Source: S&P/LCD/Capital IQ 11

12 1Q98 May-99 Jan- Sep- May-1 Jan-2 Sep-2 May-3 Jan-4 Sep-4 May-5 Jan-6 Sep-6 May-7 Jan-8 Sep-8 May-9 Jan-1 Sep-1 May-11 Jan-12 Sep-12 May-13 1Q98 May-99 Jan- Sep- May-1 Jan-2 Sep-2 May-3 Jan-4 Sep-4 May-5 Jan-6 Sep-6 May-7 Jan-8 Sep-8 May-9 Jan-1 Sep-1 May-11 Jan-12 Sep-12 May-13 All-in spread (bps) All-in spread (bps) New issue loans: Institutional term loan spreads Contracting, but well above pre-crisis lows BB/BB- rated institutional term loans B+/B rated institutional term loans LIBOR floor benefit Amort OID Straight Spread LIBOR Floor Benefit Amort OID Straight Spread Source: S&P/LCD/Capital IQ 12

13 The Regulatory Environment: Risk retention & Leveraged Lending Guidance & Volcker, Oh My! 13

14 Risk Retention 14

15 Q13 Investor primary mkt share (%) CLOs are the biggest non-bank lender If they are no longer viable, what happens?... 8% Investor Market Share in Primary Institutional Loan Market 7% 6% 5% 4% 3% Hedge funds/hy funds Loan mutual funds CLOs 2% 1% % Source: S&P/Capital IQ/LCD 15

16 % of respondents Risk Retention Shutters CLOs: According to an LSTA survey, market shrinks by more than 75% 6 CLO managers say their CLOs under mgt would drop 88%... 8% Managers estimate the overall CLO market would shrink by 75% % 4 6% 5% Impact on market's mgt % 3% 2% 1% CLOs currently under mgt How many CLOs could you do if you had to retain 5%? The LSTA asked managers running 7% of U.S. CLOs whether they could manage CLOs if they were required to retain 5% of the fair value of any new CLOs According to the LSTA Survey, managers, who currently manage more than 5 CLOs, said they would only run approximately 7 CLOs in total if the risk retention rules went into effect as originally written (left) They estimated it would reduce the CLO market by 75% (right) and this is before the disruptive horizontal retention cash flow diversion language 16 % No Impact Shrink it 5% Shrink it 75% Stop it altogether Source: LSTA Manager Survey, July 213

17 Jan-Oct Jan-Nov 13 U.S. CLO formation Euro CLO issuance ( Bils.) Without risk retention (yet), U.S. CLO formation has recovered; European CLO formation has collapsed 12 1 U.S. CLO formation has recovered European CLO formation has collapsed Source: Thomson Reuters LPC Source: S&P/Capital IQ/LCD U.S. CLO formation has recovered, bringing capital to U.S. companies European CLO formation collapsed, due in part to risk retention rules 17

18 Performance: CLO note impairments have been all but non-existent Cumulative impairment rate from Jan 1996 to May 212 Unimpaired 98.57% Impaired 1.43% Over the course of 17 years, the cumulative impairment rate of CLOs has been de minimus less than 1.5% in that entire time span Losses will be lower than impairments, because impairments can include market value EOD, distressed exchanges, etc., in addition to realized losses Source: Moody s Investors Service 18

19 Why should I care if the CLO market shrinks? Scenario 1: Other credit providers do not step in leveraged loan market contracts reducing availability of credit to non-ig borrowers (particularly in the middle market) Scenario 2: Other credit providers (such as HY bonds) do step in but magnitude of replacement depends on elasticity of demand margins increase increasing the cost of credit to non-ig borrowers Scenario 3: Other credit providers (such as loan mutual funds) do step in but this replaces match-funded investors with maturity transforming investors possibly increasing the volatility of the loan asset class 19

20 Leveraged Lending Guidance 2

21 Leveraged Lending Guidance Areas of explicit focus include (but are not limited to ) Defining leveraged loans leverage, purpose, HLT definition, RE secured loans, etc Underwriting standards delevering ability, covenants Pipeline management Enterprise valuation Reporting and analytics Risk rating loans Deal sponsors Stress testing Particular areas of focus (or so we hear ) Ability to amortize senior secured debt or 5% of all debt in 5-7 years Covenant lite loans Applies not just to loans held by banks, but also loans arranged (but not held) by banks Defining Concept (?): Banks should not underwrite loans they are not willing to hold 21

22 Jan Mar Apr Jun Aug Oct Dec Jan Mar May Jul Sep Nov Feb Apr Jun Aug Oct Dec Jan Mar May Jul Sep Nov Feb Apr Jun Aug Oct Dec Jan Mar May Jul Sep Oct Feb Apr Jun Jul Sep Pipeline ($Bils.) Institutional term loan pipeline being managed tightly Institutional Loan Pipeline Below 27 Levels Source: Thomson Reuters LPC 22

23 Jan-6 Apr-6 Jul-6 Oct-6 Jan-7 Apr-7 Jul-7 Oct-7 Jan-8 Apr-8 Jul-8 Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Amount ($Bils) Share (%) There definitely are more covenant lite institutional term loans Covenant lite loan volume/share in the S&P/LSTA Leveraged Loan Index 65 1% Cov-lite vol Cov-lite share 8% 6% % % 5 % Covenant lite loan issuance now comprises half of new issue institutional loans and 4% of outstanding loans These loans do not have maintenance covenants, but do have incurrence covenants They returned because they performed well: Lower default incidence and higher recovery given default in the crisis Source: S&P/LSTA Leveraged Loan Index 23

24 Amt ($Bils.) Amt ($Bils.) Leveraged Lending Guidance and the SNC Review 7 Criticized assets (27-213) Criticized assets ( ) 18 6 Loss Doubtful Substandard 12 4 Special Mention Special Mention Substandard Doubtful Loss In the 213 SNC Review, Classified Assets decreased, but Criticized Assets increased This was primarily driven by an increase in Special Mention loans SNC Review referenced the Leveraged Lending Guidance and observed that a focused review of leveraged loans found material widespread weaknesses in underwriting practices, including excessive leverage, inability to amortize debt over a reasonable period, and a lack of meaningful financial covenants. 42% of leveraged loans were criticized Source: 213 SNC Review 24

25 How might Leveraged Lending Guidance impact the leveraged market? Background: The HLT designation from the early 199s helped launch the institutional term loan market What is happening with the market today? Generally mass confusion What might ultimately happen?... Banks figure out how to comply; the market continues? Banks back away from leveraged lending; the leveraged finance market shrinks? Banks back away from leveraged lending; senior secured floating rate market develops? Banks back away from leveraged lending; non-bank originators step in? 25

26 Ultimately, today s leveraged loan market is simply responding to supply and demand cues But longer term, regulation may drive the evolution (or devolution) of the leveraged loan market 26