7/14/2010 Breaking Down the Wall of Debt: The Leveraged Loan Market Meredith Coffey, EVP – LSTA mcoffey@lsta.org www.lsta.org 1 Panel topics Brief review of where we have been Behind the rally (and retrenchment): The Virtuous and Vicious Cycles CLOs and the Refinancing Cliff: Progress…and a few problems The Outlook 2 1
7/14/2010 4 key U.S. large corporate loan market segments Investment grade loan market Leveraged loan market Loans to companies rated >= BBB-/Baa3 AND Loans to companies rated < BBB-/Baa3 or • • with a relatively low LIBOR spread unrated & with a high spread* 2007 lending: $658 billion Divided into bank and non-bank segments • • 2008 lending: $319 billion 2007 lending : $689 billion • • 2009 lending: $229 billion 2008 lending : $294 billion • • LTM 1H10 lending: $279 billion 2009 lending: $239 billion • • LTM 1H10 lending: $304 billion • Institutional loan market Secondary loan market Leveraged loans with non-bank lenders (such as Market in which loans trade following the close of • • mutual funds, CLOs, insurance companies, primary syndication hedge funds, etc) Most U.S. loan trading involves leveraged loans • 2007 lending: $426 billion • 2007 trading: $520 billion • 2008 lending: $69.6 billion • 2008 trading: $510 billion • • 2009 lending: $56 billion 2009 trading: $474 billion • • LTM 1H10 lending: $126 billion *Traditionally LIB+150, increased to LIB+350 in 1Q09 Source: Reuters LPC for primary lending; LSTA for secondary trading 3 Last 12 months have seen a considerable recovery… …And a retrenchment U.S. Index bid levels (2000-6/10) 105 Bid (% of par) U.S. Index bid levels (2009-6/10) 100 95 95 90 90 85 85 80 80 75 70 75 U.S. Index bid levels (2010td) 65 70 93 60 65 1/7/2000 1/7/2001 1/7/2002 1/7/2003 1/7/2004 1/7/2005 1/7/2006 1/7/2007 1/7/2008 1/7/2009 1/7/2010 92 60 1/1/2009 3/1/2009 5/1/2009 7/1/2009 9/1/2009 11/1/2009 1/1/2010 3/1/2010 5/1/2010 7/1/2010 91 90 89 88 Loan prices dropped more sharply than in the 2001-2002 downturn 87 There were multiple drivers to the downturn 1/1/2010 1/22/2010 2/12/2010 3/5/2010 3/26/2010 4/16/2010 5/7/2010 5/28/2010 6/18/2010 7/9/2010 Loan prices rallied back very sharply in 2009 Rally continued through April 2010, but then fell victim to global jitters Source: S&P/LSTA Leveraged Loan Index 4 2
7/14/2010 After deteriorating sharply, U.S. fundamentals improve S&P/LSTA Leveraged Loan Index default rate 12% 10% 8% Default rate (%) 6% 4% 2% 0% 12/31/1998 4/30/1999 8/31/1999 12/31/1999 4/30/2000 8/31/2000 12/31/2000 4/30/2001 8/31/2001 12/31/2001 4/30/2002 8/31/2002 12/31/2002 4/30/2003 8/31/2003 12/31/2003 4/30/2004 8/31/2004 12/31/2004 4/30/2005 8/31/2005 12/31/2005 4/30/2006 8/31/2006 12/31/2006 4/30/2007 8/31/2007 12/31/2007 4/30/2008 8/31/2008 12/31/2008 4/30/2009 8/31/2009 12/31/2009 4/30/2010 Loan default rate did hit record high Default rate already dropping Many companies exiting bankruptcy But the recovery is more about technicals than fundamentals Source: Standard and Poor’s/LCD 5 The Virtuous (refinancing) Cycle Record volume of outstanding institutional corporate loans 1. Nearly half are held in CLOs 2. CLO reinvestment periods will end 3. But loans must be repaid 4. The gap between borrowers’ refi needs and CLO refi ability is the refinancing cliff 5. Issuers and bankers focus on paying down the “refinancing cliff”, using HY bonds 6. Repayments go back into CLO wallets 7. CLO money needs to be reinvested now 8. CLOs buy loans in primary/secondary 9. With little supply, this creates excess demand 10. Loan terms become much easier 11. Markets cheer… 12. But what happens if the Virtuous Cycle Stops?... 6 3
7/14/2010 U.S. HY bond issuance very strong through April 2010, Declines significantly in May and June Monthly HY bond issuance 40 35 30 Volume ($Bils.) 25 20 15 10 5 0 Jul-08 Aug-08 Sep-08 Nov-08 Dec-08 Jan-09 Feb-09 Jun-09 Jul-09 Aug-09 Sep-09 Nov-09 Dec-09 Jan-10 Feb-10 Jun-10 Oct-08 Mar-09 Apr-09 May-09 Oct-09 Mar-10 Apr-10 May-10 HY bond issuance revives in 2H09, accelerates in1Q10 Proceeds repay loans HY issuance drops sharply in May Source: Thomson Reuters LPC 7 U.S. HY bond outstandings climb, Loan outstandings shrink HY market outstandings Change in outstandings (2009 vs. 2008; 5/10 vs 2009) 1600 200 1400 High-Yield Change (5/31/10 vs YE 2009) Second-Lien Institutional 150 1200 Change in outstandings ($Bils.) Outstandings ($Bils) First-Lien Institutional Change (YE 2009 vs. YE 2008) 1000 100 800 600 50 400 0 200 First-Lien Second-Lien High-Yield Institutional Institutional 0 -50 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 YTD 5/31/2010 -100 • The market began to address loan maturities • HY bonds repaid loans, and loans saw other partial/full paydowns • Inst. loan outstandings declined more than $60 billion in 2009, and another $25 billion through May 2010 Source: S&P/LCD, Merrill Lynch 4
7/14/2010 Technicals (and fundamentals) lead to strong rally U.S. Index bid levels (2000-6/10) 105 Bid (% of par) U.S. Index bid levels (2009-6/10) 100 95 95 90 90 85 85 80 75 80 70 U.S. Index bid levels (2010td) 75 65 93 60 70 1/7/2000 1/7/2001 1/7/2002 1/7/2003 1/7/2004 1/7/2005 1/7/2006 1/7/2007 1/7/2008 1/7/2009 1/7/2010 92 65 91 60 1/1/2009 3/1/2009 5/1/2009 7/1/2009 9/1/2009 11/1/2009 1/1/2010 3/1/2010 5/1/2010 7/1/2010 90 89 88 Loan prices dropped more sharply than in the 2001-2002 downturn 87 There were multiple drivers to the downturn 1/1/2010 1/22/2010 2/12/2010 3/5/2010 3/26/2010 4/16/2010 5/7/2010 5/28/2010 6/18/2010 7/9/2010 Loan prices rallied back very sharply in 2009 Rally continued through April 2010, but then fell victim to global jitters Source: S&P/LSTA Leveraged Loan Index 9 U.S. Institutional loan calendar strengthens in 2010 U.S. Institutional loan pipeline 20 18 16 Volume ($Bils.) 14 12 10 8 6 4 2 0 Mar Apr Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May June July 2009 2010 After a two-year hiatus, the U.S. institutional loan pipeline begins to fill And then, PIIGS II strikes… Source: Thomson Reuters LPC 10 5
7/14/2010 U.S. loan and HY bond prices slide U.S. HY bond vs. inst. loan bids U.S. HY bond and inst. loan bids (Change from YE09) 102 6 100 BAML US HY 5 Price Change in bid (pts) 98 4 Bid (% of par) S&P/LSTA Index 96 Price BAML US HY Price 3 94 S&P/LSTA Index Price 92 2 90 1 88 0 86 1/4/2010 1/12/2010 1/20/2010 1/28/2010 2/4/2010 2/12/2010 2/22/2010 3/1/2010 3/9/2010 3/17/2010 3/25/2010 4/5/2010 4/13/2010 4/21/2010 4/29/2010 5/7/2010 5/17/2010 5/25/2010 6/2/2010 6/10/2010 6/18/2010 6/28/2010 7/6/2010 1/4/2010 1/12/2010 1/20/2010 1/28/2010 2/4/2010 2/12/2010 2/22/2010 3/1/2010 3/9/2010 3/17/2010 3/25/2010 4/5/2010 4/13/2010 4/21/2010 4/29/2010 5/7/2010 5/17/2010 5/25/2010 6/2/2010 6/10/2010 6/18/2010 6/28/2010 7/6/2010 -1 -2 After strong run up, both U.S. loan and HY bids slump HY bond prices recovering, loan prices lagging Source: S&P/LSTA Leveraged Loan Index, Merrill Lynch 11 U.S. institutional loan and HY bond issuance slumps U.S. HY bond vs. inst. loan issuance 40 35 Inst loans Volume ($Bils.) 30 HY bonds 25 20 15 10 5 0 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Issuance drops sharply in HY bond market following Euro-jitters U.S. institutional loan issuance drops, but market remains open…at a price Source: Thomson Reuters LPC 12 6
7/14/2010 Reverse flex dominates 1Q10, upward flex returns in 2Q10 Flexed loan yields much higher U.S. institutional flex activity Pre- and post-flex yields on loans that flexed in May 2010 9 15 8 10 7 Down Up Yield (%) 6 Volume ($Bils.) 5 OID over 3 yrs 5 Spread 0 4 1Q08 2Q083Q08 4Q08 1Q092Q09 3Q09 4Q09 1Q10 2Q10 Floor 3 -5 2 -10 1 0 -15 Talk Print Source: Thomson Reuters LPC Source: S&P/LCD Following May pullback, U.S. institutional loans flex up (by considerable amount) to clear market 13 U.S. loan yields retrench in 1Q10, jump in May (B/B+ rated institutional loans) U.S. institutional loan spreads (with OID, LIBOR floor) U.S. institutional loan spreads (with OID, LIBOR floor) 700 700 Libor Floor Benefit 600 Upfront fee over 3Y mat 600 Straight Spread Spread (bps) 500 500 Spread (bps) 400 400 300 300 200 200 Libor Floor Benefit Upfront fee over 3Y mat 100 100 Straight Spread 0 0 1Q98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Mar-09 Mar-10 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-08 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 ME 6/3/10 U.S. Institutional yields increase considerably in May, June 2010 Source: Standard and Poor’s/LCD 14 7
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