From Reuters.com

Loan buyback-related rating actions stir debate

–Reuters LPC is a global provider of loan market news, data and analytics to the credit markets worldwide. For real-time news and analytics from LPC’s LoanConnector, sign up here.–

A wave of downgrades tied to loan buybacks is igniting debate in the leveraged loan and CLO markets, highlighting the growing tension between CLO managers and rating agencies.

CLO managers are already facing mark-to-market losses resulting from the growing number of loans rated below triple-C in their portfolios. The proportion of CLO portfolios with 15-20% of assets rated CCC+ or below went from about 13% last month to about 37% this month, according to a May 8 research report from Morgan Stanley, which based its calculations on a sample of 527 transactions (Fig. 1).

CLO managers are now dealing with an additional problem arising from rating actions that place issuers that buy back their loans below par in technical default. These technical defaults, managers say, artificially inflate the number of distressed loans in their portfolio, increasing the likelihood that many CLOs will go static.

Loan buybacks – which occur when an issuer buys back its loans in the secondary market – have gained in popularity as issuers look to retire debt in a sub-par market and reduce interest costs.

The buybacks, typically completed via an amendment process, are not coercive in nature, giving investors the flexibility to decide whether or not they would like to tender their paper at the price being offered by the issuer. In some cases, companies use cash on hand or increased equity contributions from private equity sponsors to de-lever.

Middle market struggles to survive

–Reuters LPC is a global provider of loan market news, data and analytics to the credit markets worldwide. For real-time news and analytics from LPC’s LoanConnector, sign up here.

With the backdrop of a deteriorating economy and continued tight lending conditions, middle market borrowers felt the full effects of the paralysis. Lending capacity deteriorated even further as some lenders were busy dealing with their own liquidity problems or reevaluating their portfolios, while others were lending selectively.

Amendments dominated activity, as issuers sought covenant relief from their lenders, who, in turn, received higher spreads and hefty amendment fees.

However, some signs of life have emerged in the primary market in the last few weeks.

“We have seen some deals coming slowly into the market, and some of the larger middle market players that were on the sidelines seem to be making their way back into the market,” says one lender.

Adds another middle market lender: “But these are just very small signs and don’t signal a recovery; we can only be cautiously optimistic.”

In fact, when asked how close the loan market is to reaching a bottom, 60% of Thomson Reuters LPC Quarterly Middle Market Survey respondents say we are there now. For the rest caution prevails: one-fifth say the market may not reach a bottom for another six months, while another fifth say it might be another year.

Loans rebound in 2009, but outlook remains uncertain

–Reuters LPC is a global provider of loan market news, data and analytics to the credit markets worldwide. For real-time news and analytics from LPC’s LoanConnector, sign up here.

By Colm Doherty

After a difficult 2008 during which loan returns hit never before seen lows, the market has regained some lost ground. Year to date through April 15, loans have returned 15.5%, according to the S&P/LSTA Leveraged Loan Index. While not enough to make up for last year’s fall, it has helped investors to recoup some of the losses suffered last year. Alternatively, it’s a nice return for those who may have timed the market well and bought in the secondary earlier this year.

One notable aspect of market performance this year is that loan returns are outpacing that of other asset classes. The 15.5% return for leveraged loans easily exceeds that of cash pay high yield bonds (11.4%), high-grade corporate bonds (0.38%) and equities (-3%) (Fig. 1). Traditionally not an asset class associated with outsized returns, the dismal performance of the loan market last year has translated into far more room for upside gain compared to that seen in the past.

Loans returned 9.8% in 1Q09 specifically, their best quarterly performance ever (though it’s still overshadowed by the 23% loss of 4Q08) (Fig. 2).

January was the best month from a return perspective, hitting 7.4%, compared to 0.78% in February and 1.44% in March. The second quarter has started strongly as well, with loans returning 5.16% through April 15 (Fig. 3).

In comparison, there was more variation in cash pay high yield bond returns, as they moved from 5.32% in January to -3.35% in February and 3.4% in March. This brought the 1Q09 return to 5.3%. The second quarter also started off well for high yield bonds as they have returned 5.8% through April 16. As for equities, after a bad start to the year when returns hit -8.57% in January and -10.99% in February, the S&P 500 has rebounded strongly in recent weeks, returning 8.54% in March and 8.5% so far in April. But whether this means a bottom has been reached, or if it’s simply an indication of a bear market rally, remains to be seen, as the broader macroeconomic figures have shown no real improvement.