2010 Retrospective: The Return of Leveraged-Loans

All the excesses of the early 2000s and of the 2004-2007 periods are back, except that this time, there's no credit bubble pushing up home prices and nor credit cards and home equity loans withdrawals pushing consumer expenditures. In fact it is actually the opposite: record personal bankruptcies, record number of foreclosures, record unemployment and credit deflation and dollar strengthening for 3 years in a row. On the global view, many countries have either defaulted or obtained emergency loans and are still on their way to default.

Despite all this, market participants are the most convinced that the good old days of bubble economics are back and that the old normal will not be taken over by the new normal.

For a more detailed account of all the extremes we have reached in the past month or so, please refer to this previous post.

In the most exemplar proof that greed doesn't have any memory, here's another stone to the edifice: The return of the leveraged loans, CMBS, MBS, CLOs and CDOs. These are the very same instruments that burned and wiped out many investors and investment banks in 2008 and 2009. And now, even pension funds are rushing into these very high risk and low return investment. Good luck to those who are supposed to retire during the next 2-3 years... Thankfully, $-amounts are still very low compared to the peak.

Although we haven't reached an extreme level yet, it's still noteworthy, specially given the over-bullish outlook shown for 2011 in the following report:
Dec. 29 (Bloomberg) -- Leveraged-loan issuance in the U.S. more than doubled this year, as private-equity firms sought funds for buyouts and borrowers refinanced debt amid a rebound from the worst financial crisis since the Great Depression.

More than $369 billion of loans were raised as of Dec. 28, led by financing for the purchases of Tomkins Plc and Burger King Holdings Inc., up from $170 billion in 2009, according to data compiled by Bloomberg. Interest rates fell to 3.91 percentage points more than the London interbank offered rate on average, from 10.28 percentage points at the end of 2009, according to Standard & Poor’s Leveraged Commentary and Data.

Cheap financing will bolster the loan market again in 2011, as buyout firms seek cash for acquisitions and borrowers refinance some of the more than $288 billion in bank debt due in the next four years, data from Barclays Capital and S&P LCD show. The return of collateralized loan obligations should also create demand as investors seek out higher returns while the Federal Reserve keeps interest rates near zero.

You have this great set of fundamentals that are pushing people into bank debt and you have yield issues driving people into high yield, which has created a credit market that is absolutely phenomenal,” said John Eydenberg, global head of financial sponsors coverage at Deutsche Bank AG in New York, where he advises private equity firms. “The rocket fuel that powers financial sponsors is the credit markets.”

The S&P/LSTA U.S. Leveraged Loan 100 Index returned 9.35 percent this year as of Dec. 28, following last year’s 52.23 percent. In 2008 the index lost 28.2 percent. Gains for 2009 compare with 14.7 percent for junk bonds, based on the Bank of America Merrill Lynch U.S. High Yield Master II Index.

Leveraged loans and junk bonds are typically rated below BBB- by Standard & Poor’s and less than Baa3 at Moody’s Investors Service.
More than $14 billion flowed into leveraged-loan funds in 2010, according to AMG/Lipper data as cited in a Dec. 16 Bank of America report. GSO Capital Partners LP, which is the credit investment arm of Blackstone Group LP; and Goldman Sachs Group Inc. were among firms this year that said they were raising funds to invest in loans.

The most interesting trend “has been the influx of cross- over investors and new investors coming in and paying attention to the space, not as an opportunistic play, which I think was the story in 2009, but as a core allocation,” Stoeckle said. New investors include pension funds, traditional fixed-income bond accounts and some hedge funds, he said.

Insurance companies, prime-rate funds and separate-managed accounts have also expressed interest, said Tim Broadbent, head of Americas leveraged-loan syndicate at Barclays Capital in New York.

It’s a pretty broad and diversified base of buyers that is likely to continue,” he said in a telephone interview.

New CLOs, a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return, increased this year. More than $3.4 billion were issued in the U.S., more than double 2009’s $1.22 billion volume though still below the 2007 peak of $91.1 billion, Bloomberg and Morgan Stanley data show. Morgan Stanley predicts issuance of $15 billion to $20 billion in 2011.

Apollo Global Management LLC and GSO are among managers that completed CLOs. Spreads on the highest-rated portion of the debt, the slice rated AAA by S&P, were 215 basis points more than Libor as of Dec. 16 after widening to as much as 725 basis points in April 2009. Spreads were as narrow as 23 basis points in 2007, according to Morgan Stanley data.

The market for CLOs has “cracked open again but it is not doing so with any tremendous volume and most aggressive forecasts are for $15 billion of issuance,” Stoeckle said. “When you think of that in overall market size, that is still pretty small.”

The increased loan issuance will help fund buyouts as private-equity firms sit on the sidelines with about $485 billion of uninvested capital, according to data from PitchBook Data Inc.

3G Capital announced in September it was buying Burger King for $4 billion, while Canada Pension Plan Investment Board and Onex Corp. said in July they were purchasing Tomkins. KKR & Co., Vestar Capital Partners and Centerview Partners plan to raise as much as $4.6 billion of debt to back their $5.3 billion buyout of Del Monte Foods Co., according to a regulatory filing.

“The capacity for the market on the LBO side just isn’t there to do the $30-, $40-, $50 billion dollar deals,” said Deutsche Bank’s Eydenberg. “The sweet spot in the market is in the single digits and the biggest deal of the year was Del Monte, which didn’t crest a double-digit billion. I do think 2011 will hold a $15 billion deal.”

Bank of America remains the top arranger of leveraged loans, increasing its share to 19 percent as of Dec. 28 from 16.5 percent in 2009, Bloomberg data show. JPMorgan is second with 13.9 percent of the market.
And on CMBS and MBS:
Jan. 4 (Bloomberg) -- Deutsche Bank AG, UBS AG and JPMorgan Chase & Co. are preparing the year’s first bond sales tied to commercial property loans, according to people familiar with the transactions.
Deutsche Bank and UBS are teaming up to issue as much as $2.5 billion in commercial mortgage-backed securities linked to loans on office buildings, shopping malls and hotels in what would be the largest offering of its kind since the market froze in June 2008, according to a person familiar with the deal. JPMorgan plans to sell $1.5 billion in similar debt, a person familiar with that sale said.
Wall Street banks are building a pipeline of property loans to package into bonds as investors seek higher yields while the Federal Reserve holds its benchmark interest rate near zero. Sales of securities backed by mortgages on commercial property may quadruple to $45 billion in 2011, according to JPMorgan. Issuance plunged to $3.4 billion in 2009 after the credit markets seized during the financial crisis.
“CMBS new issue still offers attractive returns relative to other fixed-income products,” said Andrew Solomon, a managing director at Angelo Gordon & Co. in New York. “Even with new issuance picking up steam, the net supply of CMBS is still shrinking while demand is increasing. I’m pretty sure that means spreads are going to continue tightening.”
Both the Deutsche Bank and UBS transaction and the JPMorgan offering are slated for next month.
Yields Fall: Top-rated securities tied to commercial mortgages yield 2.25 percentage points more than the benchmark swap rate, compared with 3.95 percentage points a year ago, according to a Barclays Plc index. The spread was as high as 12.4 percentage points in March 2009 as investors fled to the safety of U.S. government debt amid uncertainty over how policy makers would resolve the financial crisis.
Sales of commercial mortgage-backed securities are a boon for property owners that have struggled to refinance maturing loans amid a dearth of new lending. About $61.3 billion in property loans packaged into bonds comes due in 2011, according to JPMorgan.

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