CLOs in the Heartland April 26, 2016
Opening Remarks Jill Zelter, Managing Director, Fitch Ratings
State of the Capital Markets: First Quarter 2016 Review and Second Quarter 2016 Outlook April 26, 2016 Randy Schwimmer Senior Managing Director Head of Origination & Capital Markets Churchill Asset Management T (212) 478-9203 M (646) 584-1362 randy.schwimmer@churchillam.com
Capital Markets Review – First Quarter 2016 Volatility eases as market conditions stabilize • US public markets recovered from 4Q lows; dovish Fed eases investor worries about inflation; China, commodities, and energy take back seat • HY issuance has modest comeback as fund flows reverse; bond volume at $35.5B, flat to last quarter, but off sharply from $91.6B for 1Q 2015 • $41B of US leveraged loans was 18.6% off previous quarter ($50.4B) – worst • $41B of US leveraged loans was 18.6% off previous quarter ($50.4B) – worst quarterly performance since 2011; retail loan funds broke a 32-week streak of outflows in March; YTD still negative at $4.9B • Middle market sponsored volume of $6B (est.) is lowest in six years • Risk retention worries and below-hurdle equity returns grind new CLO formation to near-standstill of $7.1B (vs $25.3 for 1Q 2015) Sources: S&P Capital IQ, Thomson Reuters LPC CLOs in the Heartland 4
Capital Markets Review – First Quarter 2016 What’s the setting for debt and equity INVESTORS? • Low-rate, low-growth environment remains challenging for PE returns; purchase price multiples close to record highs • 1Q saw advantage swing to the buy-side as spreads remained wide • Private credit funds continue to fundraise and invest; regulated banks retreat from highly leveraged transactions highly leveraged transactions • Chase for yield winning out over liquidity or credit concerns; institutional investors have swung back to higher risk alternatives • With BDCs cash-constrained, second lien has been disintermediated by mezzanine; unitranche and senior stretch taking larger structure shares CLOs in the Heartland 5
Capital Markets Review – First Quarter 2016 How about debt and equity ISSUERS? • Known large cap borrowers getting good terms in broadly syndicated market; story credits still struggling amid constrained market liquidity • Larger middle market arrangers with higher holds offering “club execution” alternative to syndication for increasingly bigger deals (“cargo pants” strategy”) • Sponsors getting one-stop shop solutions from private credit providers; unitranche • Sponsors getting one-stop shop solutions from private credit providers; unitranche financings providing certainty of execution • Borrowers and sponsors seeking flexibility at a price; covenants, debt baskets, and structures all continue to be issuer-friendly CLOs in the Heartland 6
Capital Markets – Behind the Scenes CLOs remain a significant share of the institutional market Institutional investor market share 11.0% 2.3% 6.8% 21.1% 58.8% Finance Co. Insurance Co. Hedge, Distressed & High-Yield Funds Loan Mutual Funds CLO Institutional investor market share Source: S&P LCD, Capital IQ CLOs in the Heartland 7
Capital Markets – Behind the Scenes With deal flow down, banks’ share of loans has rebounded Primary market for highly leveraged loans (banks vs. non-banks) 100% 90% 80% 70% 60% Institutional investors and finance companies 50% Banks & securities firms 40% 30% 20% 10% 0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1Q16 Institutional investor market share Source: Wells Fargo, S&P LCD Capital IQ CLOs in the Heartland 8
Capital Markets – Behind the Scenes Correlation between asset classes has grown since the credit crisis Correlation between asset classes 100% 90% Loans vs High Yield Loans vs Equity 80% 70% 60% 50% 40% 30% 20% 10% 0% Shows cumulative correlation between indicated asset classes Source: LSTA, S&P LCD CLOs in the Heartland 9
Capital Markets – Behind the Scenes PE fundraising remains healthy, as expected… $90 120 105 05 $80 100 92 90 89 $70 81 77 77 $60 80 75 71 74 71 71 70 69 66 66 63 63 $50 $50 61 61 61 60 52 $40 49 45 $30 40 $20 20 $10 $36 $34 $25 $20 $35 $36 $27 $36 $37 $82 $35 $77 $54 $60 $41 $59 $46 $36 $45 $65 $57 $0 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2011 2012 2013 2014 2015 2016 Capital Rais ised ($B) # of Fund unds Clos osed Source: PitchBook; data for North America CLOs in the Heartland 10
Capital Markets – Behind the Scenes …while deal flow declines for third consecutive quarter $250 1,200 1,117 1,0671,060 1,02 1,070 028 1,03 030 1,02 024 985 85 956 56 957 1,000 $200 908 857 57 829 813 13 785 85 800 760 60 814 763 63 767 67 $150 $150 745 745 45 45 695 600 $100 400 $50 200 $108 $113 $101 $126 $104 $194 $106 $125 $149 $183 $159 $162 $172 $174 $160 $155 $198 $147 $141 $93 $99 $0 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2011 2012 2013 2014 2015 2016 Capital Inve vested ($B) # of Deal als Source: PitchBook; data for North America CLOs in the Heartland 11
Capital Markets – Behind the Scenes Sense of market stability causes investors to reverse out-flows Prime-fund flows (weekly reports only) $2B $1B 0.51 0.39 0.25 0.17 $0B -0.75 -$1B -1.19 -1.17 -1.53 -$2B -2.12 -2.49 -2.54 -$3B -3.46 -$4B -4.66 -$5B Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2016 2016 2016 Source: S&P/LCD CLOs in the Heartland 12
Capital Markets – Behind the Scenes New CLO formation building slowly; lowest volume in four years Monthly CLO Volume $18B 16.24 $16B $14B 13.39 12.74 $12B 11.30 11.16 11.29 10.18 $10B 9.38 8.26 7.73 $8B 7.46 7.33 7.35 6.02 5.57 5.66 $6B 5.15 4.81 4.20 $4B 2.07 $2B 0.83 $0B Jul 2014 Sep 2014 Nov 2014 Jan 2015 Mar 2015 May 2015 Jul 2015 Sep 2015 Nov 2015 Jan 2016 Mar 2016 Source: S&P/LCD CLOs in the Heartland 13
Capital Markets – Behind the Scenes Financing activity with sponsors slumps amid uncertainty Sponsored Middle Market Volume 30.0 Sponsored 25.0 20.0 ($B.) Issuance ($B 15.0 10.0 5.0 0.0 1Q00 4Q00 3Q01 2Q02 1Q03 4Q03 3Q04 2Q05 1Q06 4Q06 3Q07 2Q08 1Q09 4Q09 3Q10 2Q11 1Q12 4Q12 3Q13 2Q14 1Q15 4Q15 Source: Thomson Reuters LPC CLOs in the Heartland 14
Capital Markets – Behind the Scenes LBO leverage is down, thanks to Leveraged Lending Guidance 7.5x 55% Institutional MM Large Corp. Institutional MM Large Corp. 7.0x 50% 6.5x EBITDA (x) 45% ibutions 6.0x LBO Debt to EB Equity Contribu 40% 40% 5.5x 5.0x 35% 4.5x 30% 4.0x 25% 3.5x 3.0x 20% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1Q16 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 1Q16 Source: Thomson Reuters LPC CLOs in the Heartland 15
Capital Markets – Behind the Scenes Supply/demand dynamics continue favoring investors 10.0 10.0% 8.0 9.0% 6.0 8.0% (3 years) 4.0 7.0% ws ($B) 2.0 2.0 6.0% 6.0% Loan fund flows Single B-yields (3 0.0 5.0% -2.0 4.0% -4.0 3.0% -6.0 2.0% Loan fund flows Single- B loan yields -8.0 1.0% -10.0 0.0% Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 Source: Thomson Reuters LPC CLOs in the Heartland 16
Capital Markets – Behind the Scenes Better credits get better pricing; liquidity challenged regardless New-issue yield to maturity for leveraged loans 7.0% 6.5% BB B 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Source: S&P LCD CLOs in the Heartland 17
Capital Markets – Behind the Scenes Middle market illiquidity premium remains around 75 bps L+700 L+600 L+500 L+400 L+300 L+200 Large Cap Middle Market L+100 L+0 Source: S&P LCD; institutional spreads, sponsored transactions; LC = >$50mm ebitda, MM = <$50mm ebitda CLOs in the Heartland 18
Capital Markets – Behind the Scenes Middle market leveraged loan yields up fourth straight quarter 12% LIB/LIB Floor LIB Spread Spread due to OID 11% 10% 9% 3-year) 8% 7% 7% All-in-yield (3 6% 5% 4% 3% 2% 1% 0% 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 2008 1Q-3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Source: Thomson Reuters LPC; all-in middle market institutional yields (3 year) CLOs in the Heartland 19
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