Credit suisse leveraged finance market update 2016

The bank loan market had a remarkable and inauspicious It marked only the second time since the index inception in that bank loans produced negative returns. The only previous negative return occurred during the global financial crisis in There has been a confluence of both fundamental and technical factors that led to the poor return. In fact, there were three pronounced themes that emerged during the course of the year and accelerated in the fourth quarter of The bifurcation of the market, split between higher quality and lower quality.

The first theme of commodity driven sector weakness is evident in the chart below, which highlights the four worst performing sectors for the month, quarter and year.

Three of the four sector categories in fact the three sectors with the worst returns were heavily driven by underlying commodity weakness. A weakening Chinese economy led to a precipitous decline across commodity markets. Commodity driven borrowers were severely impacted by the underlying weakness in their respective sectors.

In December, selling accelerated in these industries for two primary reasons. One, some managers sought to reduce exposure to these sectors before beginning and two, the lack of distressed support and dealer balance sheets created a very steep liquidity premium. The second theme of is the bifurcation between higher and lower quality, which is evident in the chart below. There are a few dynamics at play, driving returns by ratings.

When began, there was much discussion if the economy would see a positive impact from the gas savings achieved from lower oil prices. This enthusiasm combined with the strong CLO market led to strong returns in the first half of However, as the year wore on, investors became more and more concerned about the health of the U.

There appeared to be no immediate benefit from lower oil prices and certainly not enough to allay growing fears regarding the health of the emerging markets, specifically China. Therefore, loan investors began migrating higher in quality and selling lower quality. This impact was magnified by the lack of balance sheet power at investments banks.

Trades quickly became one way as dealers now function primarily as brokers.

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High yield created a second selling pressure within the loan market. There is a large overlap in the borrower universe of loans and high yield. Generally, the senior secured loan will be notched up from the high yield rating as it is secured by the assets of the borrower. However, when triple C bonds became toxic holdings for high yield funds and prices declined precipitously, the single B related loan facilities dropped in price as well.

Certain sectors like energy, that had seen support from hedge funds and distressed oil funds in the first half of , saw virtually no support in the back half of the year, which led to a gap down in prices in Q4 Consequently, demand from CLOs for single B loans, which risk further downward ratings migration, was low.

The worst performers were consistent throughout the year. Utilities experienced weakness for two primary reasons. First, natural gas dropped This increase in reserve margin is due to the introduction of new power capacity, largely from wind, solar and some natural gas plants.

It is our opinion that the ERCOT basin reserve margin is overstated and we believe the market will see the shuttering of many coal plants, which are free cash flow negative. Retail, which traded well during the first 9 months of the year, broke down in the fourth quarter. And while there have been pockets of strength in retail, the preponderance of negative sentiment overwhelmed investor appetite and the sector began trading materially lower in the fourth quarter.

The supply-demand imbalance that has persisted throughout the fall continued in December. While liability spreads seem to have stabilized in December with relatively good execution occurring at the top of the capital structure, the hurdle of getting a CLO printed is quite high.

Once again the most difficult piece of the capital structure to solve for is equity, as the universe of potential buyers has shrunk with the absence of BDCAs and the fact that secondary CLO equity is trading at a steep discount to where most new issue needs to price.

As the risk retention compliance deadline looms, dealers are taking managers to market that have risk-retentions in place or well thought out risk-retention solutions. As a reminder, in October , the FDIC, along with other federal agencies, passed a final U. The reason this regulation has slowed issuance in is twofold. First, managers needed to make sure they understood the rule.

We believe a commitment of this size will eliminate many mid-size and small managers from the market, which means we will likely see a continued deceleration of CLO issuance for some time to come. I also suspect that the hurdle for what qualifies as a well thought out risk-retention solution will become higher in This also means that marked the peak year in CLO 2. The second largest component of leveraged loan demand is derived from retail funds.

Retail funds have witnessed persistent outflows this year, especially in the last few months. In fact there have been 23 consecutive outflows to end the year despite the increase in interest rates, which has historically created demand for loans. High yield outflows also weighed on the loan market as crossover sellers emerge every time the high yield market has large outflows.

Weak demand and weak loan returns seemed to be reflective of each other and can be seen below. On the supply side of the equation, issuance was unrelenting. As common in late cycle dynamics, when companies have difficulty generating natural growth they make acquisitions.

The calendar was dominated by mergers and acquisitions. Annual new issue supply can be seen below. First, failed syndications mostly occurred in the fourth quarter. Second, many failed syndications in were opportunistic repricing a term loan to a lower coupon or financing a special dividend.

This means the deals could go away and there was no economic loss. As mentioned previously, many of these deals that had failed syndications were fully back-stopped by investment banks and will still come to market, perhaps at a price well below the planned original issue discount.

In , volumes have been driven by the mergers and acquisitions as can be seen in the chart below. Consequently, most of the forward calendar, to begin the year, will be largely unavoidable.

There has also been a widening gap between BBs and single Bs. If the default rate is based on number of issues, December marked a two-year high of 1. These sectors, however, accounted for eight of 11 issuers that defaulted during the year.

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Shadow default rates are also increasing materially. At month end, the 3-year DM was wide of the historical average at basis points.

The DM spread differential between BBs and single Bs tightened every month of the year until June. As the market weakened, single Bs have weakened more than BBs.

Single Bs are now trading wide to BBs based on historical basis. In comparison to bonds, loans outperformed HY for the first time since Since energy is a much larger component of the high yield index, one could speculate that if energy returns are again very negative in this would help bank loans on a relative basis. If we look at loans versus bonds, excluding energy, HY looks wide on a yield basis. The bank loan market suffered from both technical and fundamental issues in , which pressured loans and led to the second worst loan return since the inception of the Credit Suisse Leveraged Loan Index.

Defaults are beginning to escalate but they are still largely concentrated in commodity driven industries.

On a relative value basis, the asset class trades wide to historical valuations, and compares well to high yield on a spread basis. Further bank loans carry very little duration and should not be negatively impacted by rising rates. About Our Firm Our Partners Our People Our History Careers Contact Us Client Solutions U.

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Loan Review — April Loan Review — March Loan Review — February Loan Review — January Loan Review — December Loan Review — November Loan Review — October Loan Review — September Loan Review — August Loan Review — July Loan Review — June Loan Review — May Loan Review — April Loan Review — March Loan Review — February Loan Review — January Loan Review — December A Year in Review Monthly Commentary January 06, Quarter-to-date, the CS LLI was down For the twelve months ending December 31, , the CS LLI was down Worst Sector Returns Source: Credit Suisse Leveraged Loan Index Three of the four sector categories in fact the three sectors with the worst returns were heavily driven by underlying commodity weakness.

Bloomberg Data Commodity driven borrowers were severely impacted by the underlying weakness in their respective sectors. BY Rating Total Return Source: Credit Suisse Leveraged Loan Index There are a few dynamics at play, driving returns by ratings. Together, these three factors led to the bifurcation of returns by ratings. Sector Performance In , the sectors that generally outperformed were domestic U. December Returns by Industry Source: Credit Suisse Leveraged Loan Index Returns by Industry Source: Credit Suisse Leveraged Loan Index Technicals The supply-demand imbalance that has persisted throughout the fall continued in December.

CLO Monthly Issuance Source: New Issue Volume Source: Institutional Forward Calendar Source: New-Issue First-Lien Yield to Maturity Source: Laggingmonth Leveraged Loan Default Rate by Amount Source: Credit Suisse Leveraged Loan Index In comparison to bonds, loans outperformed HY for the first time since Loans Versus Bonds on a Yield and Spread Comparison Source: Credit Suisse Leveraged Loan Index Summary The bank loan market suffered from both technical and fundamental issues in , which pressured loans and led to the second worst loan return since the inception of the Credit Suisse Leveraged Loan Index.

Media Attachments Loan Review — December A Year in Review Monthly Commentary. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision.

TCW assumes no duty to update any forward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are subject to change without notice. Past performance is no guarantee of future results. Please select item s from the table below to continue.