Corporates

Leveraged Finance U.S. Special Report
Analysts
Darin Schmalz +1 312 606-2324
darin.schmalz@fitchratings.com

Bridging the Refinancing Cliff
Executive Summary
Fitch has evaluated the potential gap between the supply and demand for leveraged loans over the next five years, and concluded that the imbalance is much smaller than the absolute debt maturities imply. Key observations and findings include:  While recent refinancing activity has diminished a substantial portion of the debt coming due over the next two years, this activity has not eased the pressure created by the $600 billion of leveraged loans expected to mature between 2012 and 2014. Various refinancing sources will likely be strained over the next several years. However, amend and extend agreements (A&Es), bond-for-loan takeouts, increased capacity within the leveraged loan market (including a revival of the collateralized loan obligations [CLO] market), asset-based lenders from the non-syndicate loan market could reemerge to supply some loan volume and pre-payments (both mandatory and voluntary) are likely to absorb much of the demand for refinancing during this period. In particular, Fitch expects A&E volumes to continue to increase through 2014, allowing the market to redistribute loan maturities to a level more easily absorbed by traditional market sources. Also, the demand for capital could be a catalyst for renewed CLO activity in the coming years. This CLO activity could contribute meaningfully to the supply of credit available for refinancing Based on historical leveraged loan and high yield bond activity overlaid with moderate forward-looking assumptions, a gap between the supply of and demand for credit will exist from 20102014. Fitch estimates this gap will total between $50 billion and $100 billion. There are a number of material (and intertwined) swing factors to Fitch’s estimates. First, the degree of economic stability and associated risk of a double-dip recession will influence the size of the supply/demand mismatch. Second, the trajectory of the equity market and associated expansion/compression of valuations could affect the willingness of lenders and the equity markets to provide capital for refinancing.
Debt Maturity Profile
Leveraged Loans ($ Bil.) 250 200 150 100 50 0 2010 2011 2012 2013 2014 2015 2016 Source: Thomson Reuters, Merrill Lynch Master II Index. High Yield Bonds

Mike Simonton, CFA +1 312 368-3138
mike.simonton@fitchratings.com

Elizabeth Nugent +1 212 908-0157
elizabeth.nugent@fitchratings.com

Related Research
 Top-Heavy Debt Structures: Secured Debt Weighting Grows, but Flexibility Remains, Feb. 18, 2010  Speculative-Grade Credit Quality Showing Signs of Stability, Feb. 11, 2010  U.S. Leveraged Finance Quarterly Review (Fourth Quarter and Full Year 2009), Feb. 4, 2010  U.S. High Yield Default and Recovery Rates 2009 Review and Outlook, Feb. 4, 2010  Liquidity and Covenant Analysis for Large Speculative-Grade Issuers, Jan. 19, 2010  U.S. Corporate Credit Commentary: The Long March Begins, Jan. 7, 2010  U.S. Structured Finance: 2010 Outlook, Dec. 8, 2009

www.fitchratings.com

March 22, 2010

Bridging the Refinancing Cliff ($ Bil. The potential capacity of the various sources is broken down in greater detail below. which has created a significant overhang in the credit markets. The $770 billion of maturing loans represents almost 90% of the total amount of leveraged loan maturities through 2018. Bridging the Refinancing Cliff At any point in time a majority of outstanding leveraged loans are expected to mature within seven years. and that leveraged loan issuance averages between $250 billion and $350 billion per year from 20102014. Loan Refinancing A&E Agreements Bond-for-Loan Takeouts Mandatory Prepayments Other ($135) ($80) ($55) $75 $770 ($425) Leveraged Loan Market Refinancing Capacity Assuming 45% of total annual loan volume will be used to refinance loan maturities.Corporates  Fitch believes that absent catastrophic adverse economic conditions (or a peak interest rate environment). which will curtail their ability to participate in new loans or refinancing existing loans. Specifically. nearly $770 billion of leveraged loan debt comes due during the next five years. the leveraged loan market will be presented with an unprecedented concentration of debt maturities. and most high yield bonds are expected to mature within 10 years. This estimate is sensitized to account for the anticipated steady increase in the number of secondary CLOs entering their nonreinvestment periods through 2014. This phenomenon is offset by a conservative assumption of modest new CLO issuance. 2 Bridging the Refinancing Cliff March 22. over the next five years.) 800 700 600 500 400 300 200 100 0 Leveraged Loan Maturities (2010–2014) Source: Fitch Ratings. Historically. In general. 2010 . However. much of which was funded initially by the now-dislocated CLO market. This resulted in few funding problems in refinancing debt maturities or providing growth capital to leveraged borrowers. The chart below identifies the four sources that should meaningfully smooth the contour of the refinancing cliff. Fitch believes market forces will work to ease the pressure created by the refinancing cliff that otherwise could result in an unparalleled spike in loan default volume. the maturity profile of these asset classes has been relatively flat. the leveraged loan market could potentially absorb approximately $425 billion of the refinancing cliff. the market is likely to find a clearing price and associated terms at which much of the demand for credit can be satisfied.

Loan Refinancing Capacitya 106 102 101 88 81 Year 2010 2011 2012 2013 2014 Total Leveraged Loan Maturity Schedule 53 110 197 194 214 Impact on Refinancing Cliff (53) (102) (101) (88) (81) (425) a Sensitized for lost refinancing capacity due to an increase in number of CLOs entering their non-reinvestment period. if both the economy and credit markets improve. 2006. While Fitch believes new and existing lenders will begin to re-enter the market and put money back to work.S. In general. 2010 3 . with some transactions extending to seven years during the peak of the market. Fitch believes that the refinancing cliff could be a potential catalyst for new primary CLO issuance in the coming years. many middle-market borrowers that would have otherwise turned to the asset-based loan market for financing were able to receive financing in the cash flow loan market. Loan Issuance Used For Refinancing 113 124 135 146 158 Net Lev. due to the easy credit environment from 2005-2007. However. the U. Bridging the Refinancing Cliff March 22. On average. peaked in 2007. with 2010 volume in the $3 billion to $5 billion range. While the timing of amortization will depend largely on portfolio construction and the structure’s reinvestment terms. Loan Issuance 250 275 300 325 350 Portion of Total Lev. Further complicating the issue is the rapidly increasing number of CLOs entering their amortization period from 20102014.Corporates Leveraged Loan Refinancing Capacity ($ Bil. it will be a slow process. could increase the supply of providers of loan capital. it is possible that traditional asset based lenders will step back in to contribute capital to these entities.) Potential Total Lev. For example. CLOs originated in that year. and 2007. given that the nature of CLO demand is likely to change. Primary CLO issuance may pick up in the second half of 2010 if transaction economics become attractive. was issued over the course of 2005. amortization of CLOs originated during the peak of the market will accelerate in 2010 and meaningfully pick up pace through 2012. Nearly 80% of current CLO outstandings. Unlike most asset-based loans. loan market will lose approximately $225 billion in new funding capacity between 2010 and 2014.S. partially offsetting the reduction in investment capacity of existing CLOs. Fitch does not expect loan issuance levels will reach the magnitude seen from 20052007 over the next four years. Fitch’s annual leveraged loan issuance estimates are consistent with issuance levels from 19982003. Based on this assumption. Fitch expects only moderate growth in CLO issuance in the near term. Fitch estimates that CLOs today hold over 50% of all outstanding leveraged loans in the market. in a potentially rising interest rate environment. prior to the dramatic expansion of the structured finance market.S. A potential funding problem arises in 20122014 when approximately $320 billion of institutional loans are expected to mature and will need to be refinanced  most of them held by CLOs. While it is likely that a sustainable CLO market would not include many of these marginal credits. or approximately $200 billion. CLO structures included a five-year reinvestment period. offset by new CLO issuance. The floating rate nature of loans. Source: Fitch Ratings. CLO issuance in the U. This will materially curtail the proceeds available to purchase new loans or refinance existing loans. with approximately 30% of the current balance of outstanding U. cash flow loans were syndicated by the aid of CLOs.

Assuming A&E volumes average $75 billion annually through 2014. This estimate was based on an average A&E maturity extension of approximately two years. Fitch believes the high yield bond market could absorb almost $80 billion of the loan refinancing cliff. This high yield bond issuance assumption is based. Fitch notes that the high yield market has shown adequate capacity to absorb more than $150 billion of issuance in a given year (1998. could push out a substantial amount of maturing loans beyond the 2014 time frame through the execution of A&E agreements. A&E volumes should intensify if CLOs are permitted by their documents to participate in these agreements even while they enter their amortization periods. Lenders’ and owners’ incentives are generally aligned to avoid a large number of defaults. historical data 4 Bridging the Refinancing Cliff March 22. according to Thomson Reuters. However. Chrysler Corp. A&E agreements executed in 2013 and 2014 are likely to have the greatest impact on reducing the refinancing cliff by extending maturities beyond 2014.) Potential HY Bond Issuance 125 125 125 125 125 Proceeds Used for Bond Refinancing 23 47 58 77 125 330 Proceeds Used for Growth Financing 39 16 4 5 0 Proceeds Used for Other 38 38 38 38 0 Proceeds Used for Bond-Loan Takeouts 25 25 25 5 0 80 Year 2010 2011 2012 2013 2014 Total Source: Merrill Lynch HY Master II Index. seven companies alone have almost $100 billion coming due in 20132014. on the fact that annual high yield bond issuance has averaged approximately $110 billion over the past 10 years. lenders would need to continue to support loan valuations through the execution of A&E agreements in exchange for covenant modifications and higher pricing. Fitch anticipates A&E volumes will likely exceed 2009 levels in the next couple of years.6 billion in 2009. HCA Inc. and Realogy Corp.. Most lenders are likely to arrange an A&E on favorable terms rather than endure a default or a difficult restructuring that could result in substantially lower loan recoveries. 2009). Ford Motor Co. 20032004. First. this activity could be constrained as banks may be unwilling to provide debt that matures after the $500 billion of bond debt that comes due from 20142017. Companies such as TXU Corp.. Given the concentration of a large volume of loan maturities among a small number of issuers. High Yield Bond Refinancing Capacity ($ Bil. High Yield Bond Market Refinancing Capacity Assuming a relatively aggressive average annual high yield bond issuance of approximately $125 billion from 20102014. Given this assumption. Fitch believes that the refinancing cliff could be reduced by approximately $135 billion. two assumptions would have to materialize. Fitch Ratings.. For example. Complications arise when borrowers with loan maturities in the 20132014 time frame and bond maturities in the 20152017 time frame may be required by their banks to execute more comprehensive refinancing solutions that address their bond maturities and bank extensions simultaneously to ensure new bank debt expires before other debt.Corporates ‘Amend and Extend’ Continuation A&E volume reached $60. 2010 . Secondly. however.. in part. Univision Communications Inc. For the $75 billion figure to be reasonable. First Data Corp..

Fitch believes that the longer-term portion of the refinancing cliff can be absorbed largely by a combination of A&E agreements. such as capital expenditures. a year in which 75% of all high yield proceeds were used for refinancing. Fitch anticipates that future use of proceeds will be more diverse than in 2009. default activity during this period is dependent on the degree to which these elements of credit supply (described above) materialize. Fitch assumes approximately 50% of high yield bond proceeds will be used for refinancing bonds and growth financing from 20102014. Bridging the Refinancing Cliff March 22. the refinancing cliff could be reduced by approximately $55 billion. First. Conclusion The refinancing cliff from 20102014 might be far less precipitous than the absolute debt amount suggests. Furthermore. based on an analysis of FCF to secured debt for Fitch’s speculative grade portfolio. This estimate takes into account the bond market’s current capacity to refinance approximately $330 billion of high yield bonds coming due during this period. and an expanded high yield bond market. Markets have historically adapted to supply and demand mismatches with product introductions. Prepayments Assuming that prepayments (mandatory and voluntary) reduce the outstanding leveraged loan balance by 7% per year. These estimates would prove conservative if a strong equity market during this time period resulted in (deleveraging) IPO exit strategies for a number of large LBOs. Second. Higher valuation multiples could also enhance the willingness of lenders to provide capital that could be used for refinancing. unique market variations and adjustments to pricing and terms. issuance levels in excess of $130 billion in a given year tend to drop precipitously the following year. acquisitions. If 5% of the amount coming due each year defaulted then defaults could account for $35 billion to $50 billion of the “Other” category. which is consistent with historical averages. The 7% figure is predicated on two assumptions. excess cash flow sweeps and voluntary prepayments could reduce the refinancing cliff by approximately 4% annually. Fitch believes asset sales and equity sweeps could reduce the refinancing cliff by an additional 3%. Fitch concludes that approximately 20% of total high yield bond issuance proceeds could be targeted for leveraged loan refinancing annually. Fitch assumes 30% of total new high bond issuance annually will be used for other corporate purposes. and dividends. 2010 5 . This is consistent with the high yield market’s historical average.Corporates would suggest that these levels are not sustainable for long periods of time. In addition to macroeconomic conditions. a slowly improving leveraged loan market and increased CLO activity. Fitch estimates that amortization. Each of these sources (as well as new product variations) are likely to flex somewhat to address the cliff such that defaults are not likely to exclusively bear the burden of the funding gap. Furthermore. Other The “Other” portion of the refinancing cliff represents the portion the market will need to absorb through an expansion of the aforementioned sources or by other means.

Fitch Ratings. 6 Bridging the Refinancing Cliff March 22. Source: Thomson Reuters.Corporates Appendix Leveraged Loan Maturity Schedule: ($ Bil.) Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Average Annual (19982009) Average Annual (Excluding Peak CLO Years) Refinancing 128 150 146 102 124 207 274 244 204 203 103 153 New Money 145 170 164 116 140 122 206 256 409 485 191 86 Total Lev. Source: Thomson Reuters. Issuance 3 14 14 25 5 12 71 35 49 106 140 274 315 59 24 LTM  Latest 12 months.) Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Average Annual (1998-2009) Average Annual (Excluding Peak CLO years) Refinancing 45 55 50 32 64 70 117 101 92 111 10 32 New Money Total Inst. Issuance 33 72 50 85 20 31 282 LTM  Latest 12 months. Issuance 273 320 310 218 265 329 480 501 612 688 294 239 377 281 Quarter/Month 1Q09 2Q09 3Q09 4Q09 Jan-10 Feb-10 LTM Feb-10 Total Lev. 2010 . Fitch Ratings. 44 82 131 112 43 12 3 9 27 65 82 171 56 26 53 110 197 194 214 68 29 Historical Data: Leveraged Loan Issuance ($ Bil. Issuance 45 55 50 32 99 118 223 241 366 426 70 56 148 66 Quarter/Month 1Q09 2Q09 3Q09 4Q09 Jan-10 Feb-10 LTM Feb-10 Total Inst.) Year Pro-Rata Loans Institutional Loans Total 2010 2011 2012 2013 2014 2015 2016 Source: Thomson Reuters. Historical Data: Institutional Loan Issuance ($ Bil.

) Year 2010 2011 2012 2013 2014 2015 2016 Source: Merrill Lynch HY Master II Index.0 15.5 6.0 0.7 0.2 4. Source: Fitch Ratings.) Month Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Monthly Average LTM Dec-09 LTM Feb-10 LTM  Latest 12 months.7 2.0 5.6 9.7 5.2 2.2 60.2 Quarter 4Q08 1Q09 2Q09 3Q09 4Q09 2Q4Q Annualized 3Q4Q Annualized Volume 8.) Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Average Annual (19982009) LTM  Latest 12 months.0 71.0 2.5 4. Total HY Bond Issuance 151 100 47 95 68 152 158 93 131 136 41 152 110 Quarter/Month 1Q09 2Q09 3Q09 4Q09 Jan-10 Feb-10 2Q4Q Annualized 3Q4Q Annualized LTM Feb-10 Total HY Bond Issuance 12 52 39 48 15 14 186 174 170 High Yield Bond Maturity Schedule ($ Bil. Volume 0. Total 23 47 58 77 125 133 125 Historical Data: ‘A&E’ Volumes ($ Bil.0 14.2 Bridging the Refinancing Cliff March 22. Fitch Ratings.7 21.9 3. 2010 7 .8 77.9 22. Source: Thomson Reuters.9 5.Corporates Historical Data: High Yield Bond Issuance ($ Bil.6 72.7 11.

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