The U.S. Leveraged Loan Market Meredith Coffey, LSTA Jonathan Insull, Crescent Capital Linda Pace, Carlyle Keith Read, Cerberus
Presentation Overview How we got here: The technicals and the buyer base Is it 2007 all over again? How regulation has the potential to change market The loan market today and tomorrow 2
The Technicals and the Buyer Base 3
1Q00 4Q00 3Q01 2Q02 1Q03 4Q03 3Q04 2Q05 1Q06 4Q06 3Q07 2Q08 1Q09 4Q09 3Q10 2Q11 1Q12 4Q12 3Q13 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Issuance ($Bils.) Outstandings ($Bils.) Institutional loan issuance and outstandings climb Institutional loan issuance S&P/LSTA Loan Index Outstandings 160 140 120 $800 $700 $600 100 $500 80 $400 60 $300 40 $200 20 $100 0 $0 Source: S&P/LCD, S&P/LSTA Leveraged Loan Index 4
Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Flows/Issuance ($Bils.) Visible (and invisible) investor demand climbs CLO issuance and loan mutual fund flows 20 Loan fund flows 15 CLO Issuance 10 5 0-5 Source: Thomson Reuters LPC 5
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 Dec-13 Jan-14 Feb-14 Mar-14 Assets Under Management ($Bils.) CLO AUM climbs moderately; Loan mutual fund AUM more than doubles CLO and loan mutual AUM 350 300 Loan Funds CLOs 250 200 150 100 50 0 Source: Thomson Reuters LPC 6
01/01/10 04/01/10 07/01/10 10/01/10 01/01/11 04/01/11 07/01/11 10/01/11 01/01/12 04/01/12 07/01/12 10/01/12 01/01/13 04/01/13 07/01/13 10/01/13 01/01/14 04/01/14 Loan fund flows ($Bils.) 01/06/2010 04/14/2010 07/21/2010 10/27/2010 02/02/2011 05/11/2011 08/17/2011 11/23/2011 02/29/2012 06/06/2012 09/12/2012 12/19/2012 03/27/2013 07/03/2013 10/09/2013 01/15/2014 Bid (% of par) Is the loan market susceptible to a rapid shift? Loan Mutual Fund weekly flows Secondary loan market prices 2.50 100 2.00 1.50 1.00 98 96 0.50 94-92 (0.50) 90 (1.00) (1.50) (2.00) 88 86 (2.50) Source: Thomson Reuters LPC, S&P/LSTA Loan Index 7
Is it 2007? 8
1Q98 May-99 Jan-00 Sep-00 May-01 Jan-02 Sep-02 May-03 Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 Jan-12 Sep-12 May-13 Jan-14 1Q98 (90) 4Q98 (83) 3Q99 (106) 2Q00 (92) 1Q01 (58) 4Q01 (18) 3Q02 (47) 2Q03 (64) 1Q04 (149) 4Q04 (159) 3Q05 (113) 2Q06 (194) 1Q07 (232) 4Q07 (133) 3Q08 (40) 2Q09 (32) 1Q10 (67) 4Q10 (111) 3Q11 (54) 2Q12 (111) 1Q13 (304) 4Q13 (274) Spread (bps) Coupon (%) All in institutional spreads and coupons All-in spreads above 2007 Coupons low due to LIBOR 1000 12% 900 800 700 BB-/BB- B+/B 10% 8% Institutional Spread 3-Month Libor 600 500 6% 400 4% 300 200 100 0 2% 0% Source: S&P/Capital IQ/LCD 9
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1Q14 1987 1989 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 1Q14 Leverage (x:1) Coverage (x:1) Leverage multiples climbing, coverage strong LC LBO debt multiples rising Coverage ratios very strong 7 4.5 6 5 Sub Debt/EBITDA Other Sr Debt/EBITDA SLD/EBITDA FLD/EBITDA 4 3.5 3 EBITDA/Cash Interest EBITDA-Capex/Cash Interest 4 2.5 3 2 1 0 2 1.5 1 0.5 0 Source: S&P/Capital IQ/LCD 10
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1Q14 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1Q14 Issuance ($Bils.) Issuance ($Bils.) Covenant lites and second liens loans climb Covenant-lite loan issuance Second-lien loan issuance 300 35 250 30 200 25 150 20 15 100 10 50 5 0 0 Source: S&P/Capital IQ/LCD 11
Leveraged Lending Guidance 12
Leveraged Lending Guidance: The two universes Leveraged Loans redefined to include (maybe) 3x senior leverage, 4x total leverage Purpose test?... Loans to financial vehicles that make leveraged loans Fallen angels that have been modified Criticized Loans redefined to include (maybe) Inability to repay all senior secured debt or half of total debt in 5-7 years from base cash flows Leverage > 6x Covenant lite? 70% 60% 50% 40% 30% 20% 10% 0% All LC Lev Cos LC LBOs Companies with leverage >= 6x 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1Q14 Source: S&P/Capital IQ/LCD 13
Leveraged Lending Guidance: Message from the regulators on criticized assets Core objectives of Leveraged Lending Guidance Safety and soundness of banks (tied to positions held by banks) Reducing systemic risk and ensuring that bubbles or other large events don t occur e.g., don t want high risk loans in the system (tied to underwriting) How to define systemic risk Tied to Probability of Default (PD), not Loss Given Default (LGD) or Expected Loss (EL) Thus, it s not the safety of the banks position (EL) that they are focusing on, but rather PD What do we hear that regulators are scrutinizing? Ability to repay all senior secured debt or 50% of total debt from base cash flows in 5-7 years Leverage over 6x causes concern for most industries Covenant lite loans lack of maintenance covenants reduces bank oversight and thus increases PD How does this affect lending Because they are looking at systemic risk, it s not just about the bank s position If a bank underwrites a risky loan and holds nothing, it can still be tagged for unsound underwriting practices Do banks blink? Do regulators blink? Does criticized lending migrate to non-bank originators? 14
The Loan Market Today and Tomorrow 15
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 1Q14 01/04/2012 02/08/2012 03/14/2012 04/18/2012 05/23/2012 06/27/2012 08/01/2012 09/05/2012 10/10/2012 11/14/2012 12/19/2012 01/23/2013 02/27/2013 04/03/2013 05/08/2013 06/12/2013 07/17/2013 08/21/2013 09/25/2013 10/30/2013 12/04/2013 01/08/2014 02/12/2014 03/19/2014 Share (%) Flows ($Bils.) Demand: Investor base in flux? CLO and Loan fund primary market share Loan mutual fund flows (Jan 2012-April 2014) 80% 2.00 70% 60% 1.50 50% 40% Loan mutual funds 1.00 30% 20% CLOs 0.50 10% - 0% (0.50) Source: S&P/Capital IQ/LCD, Thomson Reuters LPC 16
Jan Jan Feb Mar Mar Apr May May Jun Jul Aug Aug Sep Oct Oct Nov Dec Jan Jan Feb Mar Apr Apr May Jun Jun Jul Aug Aug Sep Oct Oct Nov Dec Jan Feb Feb Mar Apr Pipeline ($Bils.) Supply: Institutional calendar climbs 90 Institutional new issue calendar (2012-2014) 80 70 60 50 40 30 20 10 0 2012 2014 2013 Source: Thomson Reuters LPC 17
Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 Bid (% of par) Bid (% of par) Loan bids climb over past few years a little softer lately 100 S&P/LSTA Loan Index bids (12/31/11-4/16/14) 99 S&P/LSTA Loan Index bids (LTM) 99 99 98 98 97 96 95 98 98 94 98 93 98 92 97 91 97 90 97 Source: S&P/LSTA Leveraged Loan Index 18
1/31/2010 3/31/2010 5/31/2010 7/31/2010 9/30/2010 11/30/2010 1/31/2011 3/31/2011 5/31/2011 7/31/2011 9/30/2011 11/30/2011 1/31/2012 3/31/2012 5/31/2012 7/31/2012 9/30/2012 11/30/2012 1/31/2013 3/31/2013 5/31/2013 7/31/2013 9/30/2013 11/30/2013 1/31/2014 3/31/2014 Yield (%) Primary loan yields tick up. Primary institutional loan yields 10% 9% 8% All-BB All-B 7% 6% 5% 4% 3% 2% Source: S&P/Capital IQ/LCD 19
05/03/02 10/03/02 03/03/03 08/03/03 01/03/04 06/03/04 11/03/04 04/03/05 09/03/05 02/03/06 07/03/06 12/03/06 05/03/07 10/03/07 03/03/08 08/03/08 01/03/09 06/03/09 11/03/09 04/03/10 09/03/10 02/03/11 07/03/11 12/03/11 05/03/12 10/03/12 03/03/13 08/03/13 01/03/14 Spread (bps) Loan and bond yields very close Loan and bond swapped spreads 2000 1800 1600 1400 Loan Spread Bond Swapped Spread 1200 1000 800 600 400 200 0 Source: Thomson Reuters LPC 20