The LCD quarterly buy-side survey shows managers see constructive conditions in the short to medium-term.
LCD Capital IQ performs a quarterly survey that gauges the sentiment of loan managers and polls their default rate forecast. The results provide valuable insight into the fundamentals that will drive the loan market over the next few months.
The default rate forecasts remains steady at 1.8%, which was the rate quoted when the survey was last performed in March. The value excludes TXU1, which has been trading around 70 cents on the dollar and would increase the default rate to 5.1%.
Three key reasons why loan outlook is positive:
- Reduced maturity wall
- Short watch list of distressed loans
- Ongoing economic recovery
Near-term maturities greatly diminished
The tsunami wave of refinancings observed over the past few months lowered the near-term maturities (e.g. 2013-2015) from $67 billion to currently $29 billion. See our recent article on “Nothing left to refinance“.
Year to date, approximately 60% of all loan transactions were for refinancing existing debt and loans. Over the past 30 days this amount fell to close to 40%. The large amount of opportunistic repricings and refinancings led to a depletion of the maturity wall coming up in 2013-2015, which greatly reduces the probability of default.
Few companies becoming likely default candidates
Aside from TXU and Cengage2, the list of near-term likely bankruptcies is quite limited. According to LCD, as of mid-June, only 0.26% of outstanding loans were rated CCC+ or lower and trading below 70 cents on the dollar.
Additionally, the share of loans rated CCC+ or lower remained within the 12-month band of 8.5%-9.6%, showing there has not been a meaningful deterioration of credit conditions in the market.
Economic recovery will strengthen cash flows
Finally, the slow yet steady recovery will strengthen the cash flows of companies over the medium-term, which will strengthen the credit profile of several loans. Even during the meager first quarter of 2013, the cash flow coverage3 of the issuers in the S&P/LSTA Index4 increased from 2.7x to 3.0x.
The Federal Reserve has been quite clear that a tapering of monetary easing will come at the same time as improving economic conditions, which should improve the economic performance of companies and lower overall default rates despite potentially increased costs of borrowing.
The loan market may remain more resilient as the economy recovers and there is reduced downside in the short-term given the positive fundamentals behind the market. ETFs such as BKLN and SNLN allow retail investors to gain access to the asset class, which seems an attractive proposition to earn a decent yield with low downside.
- The circa $20bn TXU term loans are part of a $32 billion debt package composed of loans and bonds for the leveraged buyout of Energy Future Holdings (aka TXU Energy), a power utility based out of Dallas, TX. The $45 billion buyout by KKR, TPG and Goldman Sachs is the largest LBO in history, perhaps second only to Nabisco’s $31 billion LBO if adjusted by inflation (~$50 billion). The company has been distressed since the financial crisis crippled its ability to meet its huge debt burden. ↩
- Learning company focused on teaching, learning and research solutions for academic, professional and library markets. The Company has an ample suite of digital products that include web-based interactive learning and online courses for schools. ↩
- (EBITDA minus capital expenditures)/Interest expense ↩
- One of the main leveraged loan indices in the U.S. market, maintained by S&P ↩
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