The U.S.

Syndicated Loan Market

Trends in Credit Cycles and Systemic Risks

1
Introduction to Loans and CLOs
What are Leveraged Loans?
Senior Secured Loans

Corporate Capital Structure Senior

 Senior-most debt obligations in capital structure of
Revolving Credit Institutional Term Senior non-investment grade companies
Facility Loan Secured Loan  Repaid before other debt obligations and equity
holders
Junior Second
Second Lien Loan Secured
Lien
 Secured by collateral, generally a company’s assets or
or stock
 Higher Recovery Value if company defaults
Senior Unsecured/
High Yield Bonds Subordinated
Floating Rate
 Pays a base rate (historically LIBOR) plus an additional
spread
 Coupons adjust in conjunction with changes in short-
term interest rates
 Attractive yields
Equity
Covenants/Other
 Always benefit from Incurrence covenants
 Normally rated by Rating Agency's

Source: Credit Suisse

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 Who have been borrowers of U.S. Leveraged Loans?

Note: The logos on this page are trademarks and service marks belonging to the respective companies shown above
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What are “Institutional” Term Loans and Who Invests in
Them?
• Part of a “leveraged loan” • Who are Institutional Investors?
• A term loan that: • Pension funds
• Is drawn at inception • Insurance companies
• Has minimal amortization • Sovereign wealth funds
• Is repaid at maturity (or pre-paid • Private wealth funds
before maturity) • Trust companies
• Typically has 6-7 year maturity • Family offices
• Is usually callable at par at any time • Asset managers
• Also called “Term Loan B” or TLB

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How a CLO Works: Transparent Portfolio of Loan Assets That
Support CLO Debt and Equity
Illustrative Underlying Credit Assets Illustrative CLO Balance Sheet
Class A Notes
[Aaa/AAA]
[60 - 62] %

Cashflows
Class B Notes
[AA]
[9 - 13] %
Class C Notes
[A]

Assets [5 - 9] %
Class D Notes
[BBB]
[4 - 6] %
Class E Notes
[BB]

Losses
[4 - 6] %
Subordinated Notes
Not Rated
[9 - 11] %
 CLOs invest in pieces of loans to mostly well-known U.S. and international companies
 The interest and principal of the loans pay the interest (and principal) of the CLO notes, starting at the AAA notes and working the way down the
waterfall
 If there are losses on loans from defaults, those losses impact the equity holdings first

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Investments in CLO are Reasonably Transparent – and Very Safe
at the AAA Level

• Within the bank universe, both

U.S. banks and Japanese banks
have significant investments in
CLOs.
• Japanese banks hold roughly $80
billion of outstanding CLO notes,
while. U.S. banks hold roughly $90
billion of U.S. CLO notes.
• There remains transparency with
who holds CLOs.

Source: LCD
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CLO Investments are Very Transparent: Top 50 Holdings
in US CLOs

Source: LPC CLO Intelligence

8
Lifecycle of a CLO
•The manager and the arranger determine the key features of the deal, and start negotiations with initial investors. The
Pre-pricing manager starts to identify and purchase assets, often with the use of a warehouse facility. This process starts up to
several months before pricing.
•Commitments are finalized and discount margins (or fixed coupons) for the liabilities are determined. Closing typically
Pricing occurs two to four weeks later, at which point interest starts to accrue.
•Usually, the manager does not have the full portfolio purchased by the time of pricing, and has a ramp-up period (six
Ramp-up months is common) to purchase the remaining assets. Once the target portfolio size has been reached, the CLO passes
the effective date, at which point various coverage and portfolio quality tests start to apply.
•CLO equity investors can exercise the rights to call a deal after a non-call period (typically 2 years for 2.0 deals). When
Non-call period calling the deal, equity investors repay the debt tranches at par, through refinancing proceeds or from the sale of the
loan portfolio.
•Equity investors may be incentivized to refinance the debt tranches of the deal after the end of the non-call period to
Refi/Reset lower the cost of funding. In certain cases, they may make additional changes to the deal document such as extending
the length of the reinvestment period.
•The CLO manager actively manages the loan portfolio during the reinvestment period (typically 4+ years for 2.0 deals),
Reinvestment period using loan principal repayments and asset sale proceeds to purchase new assets. CLO investors generally do not receive
principal payments during this period as this cash is mostly reinvested in new assets.
•Once the reinvestment period ends, most loan principal receipts are allocated to CLO liabilities, usually in strict
Amortization (and
sequential order. Often loan prepayments or the proceeds of sales of assets that the manager deems credit impaired or
call) credit improved may still be reinvested. Equity investors often choose to call the deal at some point.

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Measuring Risk in the Loan Market
Comparing 2007 and 2019
 The 2007 and 2019 leveraged loan markets are very different
 Credit
 Trend: In the tenth year of a recovery, most markets, including loans, have grown
 State: Leverage has climbed, interest coverage is solid, covenants and protections are
weaker
 Impact: Future credit cycles may look similar or may see slightly higher loss experiences

 Systemic
 Trend: Since the Financial Crisis, systemic underpinnings of the market have improved
 State: There is better pipeline management and less “mark-to-market” leverage
(or “weak holders”) in the banking system
 Impact: Future dislocations should be less severe

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Credit Trends
Leverage Levels in “Highly Leveraged Transaction” Loans
8x

Sub Debt/EBITDA Other Sr Debt/EBITDA SLD/EBITDA FLD/EBITDA

6x
Leverage x:1

4x

2x

0x

• Leverage has been increasing since post-crisis lows; subordinated bond debt has been declining
• However, there is greater use of second lien loan debt, which is structurally subordinated to traditional bank loans
• *HLT loans are priced > =L+250 through 1996, >= L+225 since then
Source: S&P/LCD
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Credit Trends: Covenant Lite & Documentation
Most Institutional TLs are Now Covenant Lite
• Institutional term loans are “Covenant Lite”
90%
today. This simply means that the
institutional tranche does not have
80%
maintenance covenants; they still have
incurrence covenants and they usually are
70%
pari passu with a revolving loan that has
maintenance or springing maintenance
60%
covenants. In addition, covenant lite loans
still are senior-most in the capital structure
50%
and usually are secured by all the company’s
collateral.
40%

• There is debate as to whether covenant lite 30%

may actually reduce default rates or simply
extend the credit cycle and potentially lead to 20%
lower Recovery Given Default (“RGD”)
10%
• In addition to “covenant lite”, loan
documents do see more EBITDA adjustments 0%
and incremental debt capacity now 2007 1H19

Source: S&P/LCD
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 Credit Trends: Impact on Defaults

1Q19 Scheduled Index Loan Maturities • Background:

400
• What causes companies to default generally is
350 either the inability to repay debt or inability to
service debt
300
• There is no evidence that companies are

250 anywhere close to being unable to repay or

Volume ($Bils.)

service debt
200
• Repayment ability: There are very few near-

150
term loan maturities
• Debt service ability: Interest coverage ratios –
100 how much cash a company has to pay interest–
remain strong
50

0 • Repayment ability
2019 2020 2021 2022 2023 2024 2025 2026 2027
• As the chart indicates, there are minimal

leveraged loan debt maturities before 2022

Source: S&P/LSTA Leveraged Loan Index

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Systemic Trends
 Comparing Institutional Loans to Other Asset Classes
Loans, Like Many Markets, Leveraged Loans < 5% of Fixed Income Markets
Have Grown During 9-Year Recovery
LevLoans
4%
3,000 30000 Municipal
HY Bond IG Bond 9%
Inst Loans
Loan/Bond Outsandings ($BIls)

3% 18%
2,500 25000
BBB Bonds
2,000 20000
DJIA
1,500 15000 Treasury
Asset-
34%
1,000 10000 Backed
4%
500 5000 Money
Markets
2% Mortgage
- 0 Federal Related
1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Agency 22%
Securities
4%

Source: SIFMA, Bloomberg, LSTA, Barclays, Yahoo Finance Source: S&P/LCD

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Comparing 2007 and 2019
 Systemic trends are very different
 In 2007:
 There was considerable exposure to “weak holders” – in other words, entities holding debt that
could/would be forced to sell into a deteriorating market
 These included Total Return Swap (TRS) Investors, Market Value (“mark-to-market”) CLOs, underwriting
bank pipelines, and CLO warehouses
 In 2019:
 Bank pipeline management has become far more disciplined; despite higher total volumes, pipelines are
less than one-third the size of pre-crisis levels
 The investor base has shifted to long-term non-mark-to-market holders (like traditional CLOs).
Meanwhile, entities such as Market Value CLOs and TRS Investors are all but defunct
 Why this is critical:
 Because of these systemic changes, even if default rates increase in a cyclical downturn, the impact on
the market should be dramatically different
 There will be few forced sellers, thus limiting the downside price risk
 Long-term real money investors like traditional CLOs may use this opportunity to buy loans at attractive
prices, thus stabilizing the market

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Systemic Trends: Far Fewer “Weak Hands” in Loan Market Today
Weaker Leveraged Loan Holders
700 • In 2007, many of the leveraged loans were in “weak
hands”, i.e., holders that may be forced to sell if
600 markets deteriorated
• There are far fewer weak holders today
500 • Bank pipelines
TRS Lines
• Prior to financial crisis, banks had large pipelines of
Vol. ($Bils.)

400 CLO Warehouses

leveraged loans
BLs/Underwritten Pipeline
• When the market froze, banks were unable to
300
syndicate loans, and sold at deep discounts in a
falling market; this accelerated a technically driven
200
decline in the market
• Bank pipeline management is more robust today,
100
with pipelines generally less than 1/3 their peaks
0 • Investors
2007 2018 • There are far fewer investors that would be forced
sellers – such as TRS lines, market value CLOs and
CLO warehouses

Source: PIMCO, JPM

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 Systemic Trends: LMFs Larger Today, but have Similar Market
Share and Underwent 4Q18 Natural Experiment
Leveraged Loan Holders
(Loan Mutual Funds) • Loan Mutual Funds are larger today
200 18% • However
• Similar market share as 2007
180 16% • Approximately $20 billion of AUM is in closed end funds , thus
160 14% 10% are in daily liquidity funds
LMFs are subject to Liquidity Risk Management Rule
Loan Fund AUM ($)

140 •
12%
120 • Underwent natural experiment in December 2018 when
LMF AUM 10% redemptions hit 9% in one month
100 • Despite much larger relative outflows than HY bonds, loans
% of Mkt 8%
80 prices declined less or an equivalent amount to HY bonds
6% • Managers used sales, cash on hand and higher “Highly Liquid
60
Investment Minimum” (HLIM) to easily meet redemptions
40 4%
• See appendix for details
20 2%
0 0%
Jun-07 Oct-18 Mar-19

Source: Refinitiv LPC

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Appendix: Loan Mutual
Fund Performance
Loan and Loan Mutual Fund Performance in 2018

• Loan Market Performance & Trading Liquidity

• Open-end loan mutual funds are 10-15% of the loan buyer base
• Loan trading volumes increased during a volatile December 2018
• Loan mutual funds experienced substantial absolute and relative outflows
• Despite higher absolute and relative outflows, loan prices moved either less than or a
similar amount as high yield bond prices

• Loan Mutual Fund Liquidity Management

• Loan mutual fund managers experienced significant redemption requests
• Redemptions were managed by a combination of selling loans and using cash on hand
• We have found no evidence that managers needed to utilize their lines of credit
• Loan mutual fund managers say that the December 2018 “natural experiment” validated
their HLIM levels, HLIM warning levels and liquidity risk management plans

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 Institutional Term Loan Buyer Base
Institutional Term Loan Buyer Base Institutional Term Loan Buyer Base
(Sept 2018) (July 2019)

Other (SMA, Other (SMA,

HY, Hedge, etc) CLOs HY, Hedge, etc) CLOs
34% 50% 38% 52%

Closed-End LMF
2% Closed-End LMF
2% Open-End LMF
Open-End LMF
8%
14%

 Open-End LMFs are 8-15% of institutional term loan buyer base

 Open-End LMFs are subject to daily redemptions, nearly all other loan investors are not
 CLOs are match funded, most SMAs have periodic redemption rights with significant
notice periods
Source: Refinitiv LPC
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 Loan Trading Trends
Annualized Turnover Ratio of Loan Index
Monthly Trading Volume and Prices
$90 102 90%

Trade Vol (LSTA) Median Trade Price 80%

$80 101
70%
Trading Volume ($Bils.)

$70 100 60%

50%

%
$60 99
40%

$50 98 30%
20%
$40 97
10%

$30 96 0%

May-18

Jan-19
Apr-18

Jun-18
Mar-18

Dec-18
Aug-18

Mar-19
Oct-18
Nov-18
Jul-18

Sep-18

Feb-19
Apr-18

Dec-18
Mar-18

May-18

Aug-18

Mar-19
Jun-18

Oct-18
Nov-18

Jan-19
Jul-18

Sep-18

Feb-19

 Trading volume increased during downward price volatility (Dec 2018) and upward price volatility (Jan 2019)
 Turnover ratio trended up

Source: LSTA Trade Data Study

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 Absolute Loan Mutual Fund vs HY Bond Mutual Fund Flows
2018-2019 Mutual Fund Flows by Month
10.00
HY bond fund flows ($ Bils.) Loan fund flows ($ Bils.)
5.00

0.00

Apr-18

May-18

Dec-18
Mar-18

Aug-18

Mar-19
Jan-18

Jun-18

Oct-18

Nov-18

Jan-19
Feb-18

Jul-18

Sep-18

Feb-19
$Bils.

(5.00)

(10.00)

(15.00)

(20.00)

 Loan mutual fund flows turned sharply negative in 4Q18

 Outstripped HY bond mutual fund outflows on an absolute basis
 Loan funds are smaller than HY bond funds, so outflows even more significant on a relative basis

Source: Refinitiv LPC

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 Relative Fund Flows vs Price Changes
2018 Mutual Fund Flows by % of AUM 2018-19 Loan and HY Price Changes
4.0% 5
HY bond fund flows (% of initial AUM)
Loan fund flows (% of initial AUM) 4 HY Price Change Loan Price Change
2.0%
3
0.0%

Percentage points
2
Apr-18
May-18

Dec-18
Mar-18

Mar-19
Feb-18

Aug-18
Jan-18

Jun-18

Oct-18
Nov-18

Jan-19
Jul-18

Sep-18

Feb-19
-2.0% 1
%

-4.0% 0

Feb-18

Sep-18

Feb-19
Apr-18
May-18

Oct-18

Dec-18
Jan-18

Mar-18

Aug-18

Jan-19

Mar-19
Jun-18
Jul-18

Nov-18
-1
-6.0%
-2
-8.0%
-3
-10.0% -4

 Relative to Mutual Fund AUM, Dec 2018 outflows were much more severe in loans (-9%) than in HY bonds (-3.3%)
 However, loan price declines (-2.9 pts) were comparable to HY bond price declines (-2.6 pts)
 This, in combination with robust trading volumes, indicates that loan trading liquidity held up

Source: Refinitiv LPC, Barclays, BAML ICE Index, S&P/LSTA Loan Index, LSTA Calculations
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Loan Mutual Fund Performance in 2018

• Loan Mutual Fund Liquidity Management

• Loan mutual fund managers experienced significant outflows – more than 9%
of AUM in December 2018 alone
• How they managed it
• Sold loans (and sometimes bonds) in anticipation of redemptions
• Used cash on hand

• Impact of “natural experiment”

• Managers say December 2018 validated their HLIM levels, warning levels and liquidity risk
management plans
• While lines of credit are an important part of their liquidity plans, there is no evidence that
managers needed to utilize their lines of credit in December 2018

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