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Collateral Thinking
The next default cycle

26 September 2022
Top of the stack
Fed’s commitment to fighting inflation will result in higher for longer rates. We expect Leveraged Loan Strategy
continued underperformance of duration, especially if it accompanies worsening United States
fundamentals. Besides suppressing secondary prices, this new rate backdrop will make
high debt capital structures untenable. Loans will be the first to get hit given their
floating nature, but eventually all levered structures are bound to get impacted.

Given the state of the primary markets, balance sheet cashflows, and projected earnings
power of leveraged issuers, the path of defaults and downgrades is higher. What can
change is the severity and the overall trajectory of the experience. Regardless, we think Neha Khoda
the bulk of fundamental deterioration will transpire through downgrades rather than Credit Strategist
BofAS
defaults, and aggregate credit losses will be moderate. We expect a combined <10% of +1 646 855 9656
loan issuers to default over a span of 2-3 years, as excesses within credit today are neha.khoda@bofa.com

limited. Dong Ba
Credit Strategist
BofAS
In this report we deep dive into what drives defaults and downgrades, and what the next +1 646 855 7118
dong.ba@bofa.com
default cycle may look like. We deconstruct historic default rates by ratings, sectors and
life of loan. We discuss declining issuer cash levels, lack of primary activity, steepening Ben Gruber, CFA
Credit Strategist
maturity walls, and their combined impact on default risk. In doing so we draw BofAS
+1 646 855 8042
information from top down macro models as well as issuer level metrics around ratings, ben.gruber@bofa.com
maturities and fundamentals. Finally, we lay out our default and downgrade forecasts for
2023.
Exhibit 1: Loan performance
YTD Loan return is at -1.7%
Market Technicals
In the three weeks ending September 16th, demand for loans totaled $6.3bn, an increase YTD
from the $5.7bn of demand seen in the prior three weeks, on the back of higher coupon Index Level 1wk ∆ 2wk ∆ Rtn
All Loan 93.6 pts -0.7 -0.7 -1.7%
payments of $1.2bn. Both retail and CLO demand declined over the same period, coming BBs 96.8 pts -0.4 -0.9 +0.1%
in at $0.47bn and $0.15bn respectively. Net demand has outweighed supply Bs 93.6 pts -0.8 -0.9 -1.9%
by $82.1bn vs -$24.4bn of net demand seen this time last year. CCCs 81.7 pts 0.0 -0.2 -8.3%
Source: LCD
Rating Actions BofA GLOBAL RESEARCH

In the past month, 31 distinct issuers saw rating changes. 22 issuers were downgraded Exhibit 2: HY performance
by 32 notches and 9 issuers upgraded by 13 notches. The 3m downgrade to upgrade YTD HY return is at -12.6%
ratio has risen to 2.67x, the highest since September 2020.
YTD
Index Level 1wk ∆ 2wk ∆ Rtn
Return Performance US HY 491 bps +14 +11 -12.6%
Loans in the LCD index returned -0.41% in the three weeks ending September BBs 327 bps +10 +06 -12.5%
16th, down from the 0.89% return seen in the prior three weeks. Performance Bs 515 bps +17 +12 -12.2%
has worsened over the last three weeks across all rating categories with CCC's leading. CCCs 1196 bps +32 +35 -14.6%
Across asset classes, loans are leading with -1.7% return YTD, while is at -12.6% and IG Source: BofA Global Research
BofA GLOBAL RESEARCH
at -16.6%, the latter two being adversely impacted due to their rates backdrop.
Exhibit 3: Fund flows ($mn)
Primary Activity YTD loan inflows are at +10,038mn
YTD global issuance currently totals $219bn (-60% compared to YTD 2021) and $191bn
Asset 1wk 2wk YTD LTM
in the US (-59% from YTD 2021). The composition of deals being financed by the market Loans -749 -589 +10,038 +25,374
MTD is 75% LBO and 24% M&A. US HY +212 -1,740 -45,017 -44,823
US IG -653 -886 -129,457 -107,082
BofA Securities does and seeks to do business with issuers covered in its research Source: EPFR Global
reports. As a result, investors should be aware that the firm may have a conflict of BofA GLOBAL RESEARCH
interest that could affect the objectivity of this report. Investors should consider this
report as only a single factor in making their investment decision.
Refer to important disclosures on page 15 to 17. 12462290

Timestamp: 26 September 2022 06:00AM EDT

Top of the stack
The hawkish hike
Just when the market thought it had a handle on inflation trajectory, the Sep CPI print
proved it wrong. Broad expectation was a decline, but the print surprised to the upside.
Over the last 18 months, CPI has surprised 10 times to the upside and only 2 times to
the downside, per our economics team.
Just when consensus was building around rate trajectory, the Fed delivered a hawkish
hike. The median estimate of year end FF rate rose by 50bps in the summary of
economic projections. The Fed made large strides to prove they will fight inflation
despite the economic cost- steepened the pace of hikes, increased the projected
terminal rate, slashed GDP estimates and raised unemployment forecasts. They all but
delivered a 100bps hike, for which the bar remains high.

It’s clear to us that inflation and rates will continue to pose risk to US corporates until
we see consistent and broad based evidence of softening inflation. And we think the Fed
has aligned itself with that narrative.

There has been some pushback driven by components of the CPI report, particularly how
the upside surprise was largely dominated by owner’s equivalent rent (OER) and should
be discounted. Being a model based output some question its accuracy and relevance.
While we agree that the use of model based inputs might be suboptimal during cyclical
turning points, the discussion around it might be irrelevant. The fact is that CPI was
higher than expected, and regardless of what drove it, the Fed remains committed to
reining it in. What’s more, model outputs are sticky, implying that this is unlikely to be an
isolated elevated OER reading. To us this gives Fed a reason to be more aggressive, not
less. This is especially so in the context of how late they started the hiking process, and
how fragile their credibility has been in this rates cycle.

At the same time, we believe the Fed aims to be a source of stability and not volatility,
and will refrain from surprising the markets. They also do not want to cut rates soon
after hiking aggressively, and are likely to keep rates at moderate levels for a longer
time, than at high levels for a shorter time.

What does this mean for credit markets? As we pointed out in our last report, of the
three inflation trajectories, the least damaging one is where we learn to live in a 4-5%
headline inflation backdrop. However, this is in direct contrast to Fed’s current narrative
of restoring inflation to 2%. As such, markets may price in the substantially higher
economic cost of getting to a 2% inflation backdrop, even if the Fed doesn’t walk that
path eventually. At the minimum this will result in higher for longer rates.
This means continued underperformance of duration, especially if it accompanies
worsening fundamentals. Low quality duration products are hard to like, stuck between
high rates on one end and deteriorating earnings on the other. We reiterate our
preference for BB loans being well positioned to withstand both these onslaughts. They
don’t usually default and have the ability to pay higher interest costs. Since we first
went OW in March, BBs already outperformed the index by 1.94% and CCCs by 8.69%.
We think there is more room for outperformance even at today’s levels.

Higher rate backdrop is consequential for the entire credit market. Not only does it
suppress IG and HY prices, it also makes high debt capital structures untenable. Loans
will be the first to get hit given their floating nature, but eventually all levered structures
stand to get impacted. Below we deep dive into what drives defaults and downgrades,
and what the next default cycle may look like.

2 Collateral Thinking | 26 September 2022

Deteriorating fundamentals
Q2 earnings were sobering. Revenues and earnings managed to eke out small positive
growth, but at steep sequential declines from Q1 and the post COVID boom. In
aggregate, public loan issuers posted a 4% YoY Ebitda growth, a massive slowdown
from high double digits the quarters before. Revenue for now is propped up at 16% YoY
growth on the back of increasing prices. But by the same token, costs have gone up as
well, growing 21% YoY in Q2 vs 17% in Q1.

More concerning is the trajectory of cashflows. Cash as a percentage of debt has

materially declined from peaks reached during COVID, now near 11% (Exhibit 4). This has
mainly been a function of declining FCF levels of leveraged issuers (Exhibit 5). The
average annual FCF per issuer in our loan issuer sample now stands at $150mn, levels
last seen during the depths of the commodity crisis.

Exhibit 4: Cash as a Percentage of Total Debt Exhibit 5: LTM Cash Flow per issuer
Cash as a percentage of debt has declined from COVID peaks Cash Flow per issuer has declined to commodity crises levels
18
Cash as a Pct of Total Debt LTM Free Cash Flow per issuer (mns)
400
16

300
14

200
12

10 100

8 0
2008 2010 2012 2014 2016 2018 2020 2022 2008 2010 2012 2014 2016 2018 2020 2022
Source: BofA Global Research, Bloomberg, LCD
Source: BofA Global Research, Bloomberg, LCD
BofA GLOBAL RESEARCH
BofA GLOBAL RESEARCH

One of the main reasons for cash on balance sheet deterioration is the lack of primary
market access most of this year. This has especially hit lower quality issuers as appetite
for financing them has shrunk. The proportion of CCC issuance in the primary market on
a last 3 month basis has dropped to cyclical lows. The metric is now in its 6th month
below 5%, a level which we see as causing enough damage to balance sheets so as to
propel default rates higher. We can see the inverse correlation between CCC financing
and default rates in Exhibit 6.

Collateral Thinking | 26 September 2022 3

 Exhibit 6: Default Rates and % of CCC companies with access to the primary market
Default rates have begun to climb as low quality issuers remain unwelcome in the primary market
9%
% of CCC issuers accessing loan primary (3mo trailing) (LHS) Loan Default Rate (RHS)
50% 8%

7%
40%
6%

30% 5%

4%
20%
3%

2%
10%
1%

0% 0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022
Source: BofA Global Research, LCD
BofA GLOBAL RESEARCH

Maturities are building up

We are approaching a point where obtaining primary market financing for issuers will
transition from being optional to becoming necessary. Exhibit 7 shows a time series of
the proportion of loan index represented by maturities within the next 2 and 3 years
from point of observation. We see evidence of short dated maturity walls (0-2yrs)
building up during past instances of credit stress in 2011, 2016 and 2020. This
proportion is now at 7%, higher than the peak reached during COVID. Of course, COVID
was a short downturn and didn’t allow for pressure to build up on a long-term basis,
which is why we don’t see any maturities build up on a 0-3 year time frame. Even in the
0-3yr context, we have overtaken the commodity crisis- the pct of loans in the 0-3yr
range currently stands at 21% the highest since 2011 debt crisis.
Exhibit 7: Two and Three year maturities outstanding as a % of the loan index
Maturities are building up and may pose a problem for loan issuers
40%
Pct of Loan Index maturing next 3 yrs
Pct of Loan Index maturing next 2 yrs

30%

20%

10%

0%
2006 2008 2010 2012 2014 2016 2018 2020 2022
Source: BofA Global Research, Markit
BofA GLOBAL RESEARCH

4 Collateral Thinking | 26 September 2022

Deconstructing the default rate
Given the state of fundamentals, downgrade and default pressures have been building up
all year. The 3m downgrade to upgrade ratio recently deteriorated to 2.67x, the highest
since September 2020. The 12 month downgrade/upgrade ratio (D/U) has hit 1.1x, the
highest D/U ratio since May 2021 when the market was recovering from significantly
higher Covid-19 induced downgrades. We think there is more room for this cycle to run.
In terms of sectors, Healthcare has delivered an outsized contribution - 24% of notional
downgraded over the last twelve months, while only accounting for 12% of the index.
Utilities is the worst performing sector, with approximately 29% of the sector
downgraded. Financials have seen limited impact thus far representing the least notional
downgraded vs the index and other sectors.

Defaults have also started picking up from their record lows. While far from concerning
levels, we are clearly on a path towards increasing credit losses. Unsurprisingly, the
recent uptick has been driven by lower rated issuers. Defaults amongst CCC issuers has
risen to 3.4% on an LTM basis, up from lows of 1% in April. Bs have ticked up to 0.6%
while BBs remained level at 0.4% on an LTM basis. Historically, defaults have inflicted
CCCs the hardest. To put this in perspective, CCC defaults have wiped out as much as
50% of the rating category in the thick of a default cycle. We saw these levels reached
in 2013 and then again during COVID. Bs top out between 2-3%, while BBs don’t
represent much default risk.

The three sectors that have experienced the most defaults on an LTM basis are
Telecoms, Utilities, and Healthcare. This is in contrast to sectors with highest defaults a
year before: Metals, Transportation, and Retail.

Exhibit 8: Historical issuer default rates by broad rating

CCC carry the burden of defaults through any cycle.
14% 60%
BB DR by Count B DR by Count CCC DR by Count
12% 50%

10%
40%
8%
30%
6%
20%
4%

2% 10%

0% 0%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Source: BofA Global Research, LCD
BofA GLOBAL RESEARCH

Given the increasing relevance of the maturity wall, we also look at the default rate by
the remaining life of the loan. The instinct being that the shorter the life, the more likely
it is that the inability to extend maturities is being dictated by the market and not the
issuer. We see this coming through in Exhibit 9 where the incidence of defaults is the

Collateral Thinking | 26 September 2022 5

highest amongst loans maturing within 1 year (30-50%), and decreases amongst longer
maturities. Default rate of loans with 1-2yrs remaining peaked at ~25%, loans with 2-
3yrs remaining defaulted <10% of the time, and defaults amongst loans with 3+ yrs
remaining was negligible.

Exhibit 9: Default rates by maturity

Default rates in short maturity loans tend to increase periods of market stress
50%
0-1yr 1-2yrs 2-3yrs 3yr+

40%

30%

20%

10%

0%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Source: BofA Global Research, LCD
BofA GLOBAL RESEARCH

Defaults to reach 3%, CCCs to double in 2023

Given the state of the primary markets, balance sheet cashflows and projected earnings
power of leveraged issuers, we know the path of defaults and downgrades is higher.
What can change is the severity and the overall trajectory of the experience.

If we are able to skirt an economic recession, the default trajectory will look less like a
cycle, but more like a reset higher of baseline attrition. Higher for longer rates will make
unviable the capital structures built primarily on their ability to borrow at low cost. This
is expected to transpire as increasing debt costs and stagnant earnings impact
cashflows of low quality issuers, resulting in greater cashflow pressures and a higher
baseline of defaults and restructuring. In this situation we expect defaults to stay in the
3-4% context until front end rates remain >2%. Downgrades will likely impact 20% of
the index, with the CCC bucket doubling in size.

An economic recession, on the other hand is likely to be accompanied by a bell-shaped

default curve, where the default experience increases in severity with time. In this
situation we expect the next year to be in the 3% context, with upside pressure building
up in 2024 towards 6%. Downgrades in this scenario impact >25% of the index while
CCCs outstanding could triple.

Regardless of the trajectory, we think the bulk of fundamental deterioration will

transpire through downgrades rather than defaults, and aggregate credit losses will be
moderate. We expect a combined <10% of loan issuers to default over a span of 2-3
years, given the limited extent of excesses within credit today.

In projecting defaults and downgrades, we combine information from our top-down

models as well as bottom-up analysis discussed below. Our macro model is currently
forecasting a NTM default rate of 3%, with downgrades impacting $250bn-$300bn of

6 Collateral Thinking | 26 September 2022

loans. To complement this output, we also draw information from issuer level metrics
along three dimensions- ratings, maturities and fundamentals.

Bottom-up default and downgrade projections

The simplest way to assess default risk is by ratings. We know from Exhibit 8 that CCCs
carry the burden of defaults. We assume moderate default pressures of 2% in BBs and
30% in CCCs- lower than the 3% and 40% highs reached in COVID. Taking into account
the index weights of ratings, the overall default estimate comes to 3.3% (Exhibit 10).

Exhibit 10: Index weighted defaults by rating Exhibit 11: Index weighted defaults by time to maturity
We assume moderate default pressures in next cycle Shorter term loans could experience higher default rates than longer term
loans
Rating Est DR Index Wt Weighted DR
BBB 0.0% 3% 0.0% Life #Loans Est DR #Defaults
BB 0.5% 24% 0.1% 0-1yrs 13 40% 5
B 2.0% 64% 1.3% 1-2yrs 112 15% 17
CCC 30.0% 6% 1.8% 2-3yrs 244 7% 17
NR 4.0% 3% 0.1% 3+ 1,033 1% 10
DR projection 3.3% Total 1,402 49
Source: BofA Global Research, LCD DR projection 3.5%
BofA GLOBAL RESEARCH Source: BofA Global Research, LCD
BofA GLOBAL RESEARCH

We do the same assessment based on the current distribution of maturities. There are a
total of 369 loans maturing within the next 3 years. From Exhibit 9 we estimate the next
downgrade cycle to represent that of 2018. Applying these moderate default rates by
the number of loans in each maturity bucket currently outstanding, we get an estimated
default rate of 3.5% (Exhibit 11).

Importantly, both these are conservative assessments as the rating/maturity mix is likely
to deteriorate further from current levels, creating further upside for defaults in 2023.

Next we look at issuer fundamentals in the years leading up to default. Given the private
nature of loan issuers, the aggregate sample set of public defaulted issuers is rather
small, at 50, but provides useful insights. We take an annual snapshot of issuer coverage
starting 3yrs prior to default, and calculate median ratios across a variety of coverage
definitions such as Ebitda coverage (LTM Ebitda/LTM Int Exp), cash coverage (LTM
FCF/LTM Int Exp) as well as Ebitda w/ capex coverage (LTM Ebitda minus capex/LTM Int
Exp). Exhibit 12 shows the median ratios of this default dataset at 3 points in time
before the eventual default, T-1 here indicates 1year before default.

We find that cash coverage is a consistent and long-term problem for issuers on their
way to default, and Ebitda coverage starts touching 1x levels 1-2 years prior. Adding
back capex increases the coverage ratio, but even so, troubled issuers have a hard time
staying above 2x coverage in this context.

Collateral Thinking | 26 September 2022 7

 Exhibit 12: Median coverage ratios of loan issuers leading up to default Exhibit 13: Proportion of Companies with concerning EBITDA coverage
Cash coverage is a consistent and long-term problem for issuers on way ratios by rating
to default As rates increase, the number of companies who cannot comfortably cover
their interest payments increases
4.0
T-1 T-2 T-3 50%
Current % EBITDA CR<1.5 4.5% FF rate

3.0 40%

30%
2.0

20%
1.0
10%

0.0
Cash Coverage EBITDA Coverage Coverage w/ Capex 0%
BB1 BB2 BB3 B1 B2 B3 CCC
Source: BofA Global Research, LCD, Bloomberg
BofA GLOBAL RESEARCH Source: BofA Global Research, LCD, Bloomberg
BofA GLOBAL RESEARCH

Using this information, we set a 1.5x threshold for “concerning” Ebitda coverage in
order to assess default and downgrade pressures from a fundamental perspective. In Q2,
approximately 10% of issuers reported coverage ratios <1.5x. B2 and below rated
issuers were responsible for most of the companies under this threshold (Exhibit 13).
The proportion below 1.5x grows to 15% in a 4.5% Fed Funds rate scenario, again
B2/B3s bearing the burden of the incremental deterioration.

While only a subset of these will ultimately default, the above analysis gives us the
boundary condition for the number of downgrades to expect. As a rough measure, rating
agencies use coverage ratio thresholds of 1-2x to make assessments regarding
downgrades from B to CCC. Should 15% of the overall loan index fall below the 1.5x
threshold, this will translate to $200bn in downgrade pressures. This complements our
top down analysis (Exhibit 14) where downgrades range from $120bn-$190bn.

Exhibit 14: Net migration activity over different economic scenarios

In all three economic scenarios downgrades vastly outnumber upgrades
Scenario Rating D/G To D/G From U/G From U/G To Net Migration
BB 8 44 20 44 (11)
Slow Deterioration B 39 114 48 5 (117)
CCC 120 - 6 - 114
BB 9 55 17 39 (24)
Stagflation B 47 181 42 4 (171)
CCC 191 - 5 - 187
BB 11 60 16 39 (26)
Recession B 52 170 41 5 (154)
CCC 180 - 5 - 175
Source: BofA Global research, Moody’s
BofA GLOBAL RESEARCH

8 Collateral Thinking | 26 September 2022

Market Technicals
In the three weeks ending September 16th, demand for loans totaled $6.3bn, an increase
from the $5.7bn of demand seen in the prior three weeks ending August 26th.
This increase is attributable to an increase in coupon payments of $1.2bn. Both retail
flows and CLO creation declined slightly over the same period, $0.47bn and $0.15bn
respectively. There has not been a positive week of retail flows since the beginning of
August. Net demand has outweighed supply by $82.1bn versus the -$24.4bn of net
demand seen this time last year. Note that this table doesn't account for demand
channels such as SMAs and alternate asset vehicles.
Exhibit 15: Weekly Technicals ($mns)
Demand net of supply $82.1bn
YTD as of
9/16/2022 9/16/22 9/9/22 9/2/22 8/26/22
Retail flows (a) 8,556 -890 -695 -739 -1,065
CLO creation (b) 85,250 2,447 993 795 1,388
Coupons (c) 42,187 1,381 1,021 2,028 733
Demand (a+b+c) 135,994 2,939 1,319 2,084 1,056

Issuance Ex-repricings (d) 188,506 0 6,825 700 0

Repayments (e) 134,578 424 3,429 2,881 2,698
Supply (d-e) 53,928 -424 3,396 -2,181 -2,698

Demand net of Supply 82,066 3,362 -2,077 4,265 3,754

Source: BofA Global Research, LCD
BofA GLOBAL RESEARCH

Rating Actions
In the past month, we have seen rating actions across 31 distinct issuers. A total of 22
issuers were downgraded by 32 notches ($23.6bn total notional) and 9 issuers upgraded
by 13 notches ($6.1bn total notional). Of the downgrades, the $391mn Fly Leasing was
downgraded by four notches, and the $450mn Loyalty Ventures Inc and $400mn Rodan
& Fields were both downgraded by two notches. The 3m downgrade to upgrade ratio has
risen to 2.67x, the highest since September 2020.
In terms of sectors, 27% of total downgrades in the past month by notional were in
the Cable sector and 20% were from Healthcare. Upgrades by notional were led by
the Technology sector at 59% with Financials following at 17%. Six distinct sectors
participated in upgrades while 12 distinct sectors experienced downgrades.

Exhibit 16: Recent downgrades and upgrades

There was net downgrade activity of $17.5bn in the past month

Rating Current Previous

Issuer Ticker Margin Notional Maturity Sector Action Rating Rating Notches
Fly Leasing FLY 175 391 8/11/2025 Autos Downgrade CCC+ BB- -4
Loyalty Ventures Inc LOVEIN 450 500 11/3/2027 Technology Downgrade B- B+ -2
Rodan & Fields RODFIE 400 600 6/16/2025 Retail Downgrade CCC- CCC+ -2
Brand Energy & Infrastructure Services BRANDI 425 2,825 6/21/2024 Real Estate Downgrade CCC+ B- -1
Cablevision Systems CSCHLD 225 2,500 7/17/2025 Cable Downgrade BB- BB -1
Cablevision Systems CSCHLD 250 2,500 4/15/2027 Cable Downgrade BB- BB -1
Cablevision Systems CSCHLD 225 1,275 1/15/2026 Cable Downgrade BB- BB -1
CBS Radio CBSR 250 770 11/18/2024 Media Downgrade B B+ -1
City Brewing Company LLC CTYBRW 350 850 4/5/2028 Food Producers Downgrade B- B -1
Creation Technologies Inc CREATE 550 455 10/5/2028 Capital Goods Downgrade B- B -1
Diversified Machine Inc CHASSX 550 225 11/15/2023 Autos Downgrade B- B -1
Dole PLC DOLE 200 540 8/3/2028 Food Producers Downgrade BB BB+ -1
Empire Today LLC EMPTDY 500 425 4/3/2028 Retail Downgrade B- B -1
Gopher Resource GOPRES 325 475 3/6/2025 Services Downgrade B- B -1
ICU Medical Inc ICUI 250 850 1/8/2029 Healthcare Downgrade BB- BB -1
Innovative Chemical Products Group NAINCO 375 825 12/29/2027 Chemicals Downgrade B- B -1
Jordan Health Services Inc BWNHHC 500 660 5/15/2025 Healthcare Downgrade CCC- CCC -1

Collateral Thinking | 26 September 2022 9

 Exhibit 16: Recent downgrades and upgrades
There was net downgrade activity of $17.5bn in the past month

Rating Current Previous

Issuer Ticker Margin Notional Maturity Sector Action Rating Rating Notches
Lifescan Global LFSNGL 600 1,475 10/1/2024 Healthcare Downgrade B- B -1
Paris Presents PARISP 500 270 9/28/2025 Retail Downgrade CCC CCC+ -1
Power Stop LLC POWSTO 475 395 1/26/2029 Autos Downgrade B- B -1
PowerTeam Services POWBUY 350 775 3/6/2025 Real Estate Downgrade CCC+ B- -1
PowerTeam Services POWBUY 325 595 3/6/2025 Utilities Downgrade CCC+ B- -1
Robertshaw Controls Company ROBHOL 350 510 2/28/2025 Services Downgrade CCC CCC+ -1
Serta Simmons Bedding LLC SERSIM 750 851 8/10/2023 Retail Downgrade CCC+ B- -1
Serta Simmons Bedding LLC SERSIM 750 200 8/10/2023 Retail Downgrade B- B -1
US Renal Care Inc USRENA 500 1,600 6/26/2026 Healthcare Downgrade CCC+ B- -1
US Renal Care Inc USRENA 550 225 6/26/2026 Healthcare Downgrade CCC+ B- -1
Audio Visual Services Corp. AVSV 350 1,222 3/3/2025 Technology Upgrade CCC+ CCC 1
Audio Visual Services Corp. AVSV 550 511 10/15/2026 Technology Upgrade CCC+ CCC 1
Banijay Group BANIJA 375 460 3/1/2025 Media Upgrade B+ B 1
CCC Information Services CCCG 250 800 9/21/2028 Technology Upgrade B+ B 1
CPI International CPII 350 470 7/26/2024 Technology Upgrade B B- 1
Daseke Inc DSKE 400 400 3/9/2028 Transportation Upgrade B+ B 1
Global Cash Access LLC EVRI 250 600 8/3/2028 Technology Upgrade BB+ BB 1
Motel 6 Operating LP MTLSIX 500 300 9/9/2026 Travel Upgrade B B- 1
Arch Coal Inc ARCH 275 298 3/7/2024 Metals Upgrade BB- B 2
Getty Images Inc ABEGET 450 1,040 2/19/2026 Financials Upgrade BB- B- 3
Source: BofA Global Research, LCD

BofA GLOBAL RESEARCH

Return Performance
Loans in the LCD index returned -0.41% in the three weeks ending September
16th, down from the 0.89% cumulative return seen in the prior three weeks ending August
26th. Performance has worsened over the last three weeks across all rating categories
with CCC's leading. Across asset classes, YTD loan returns are leading with -1.7% while
YTD HY returns are behind at -12.6% and YTD IG returns are in negative territory at
-16.6%, the latter two being adversely impacted by their duration.

Exhibit 17: Total Returns (price plus coupon return), bps

Loans returned -0.19% in the week ending September 16th
9/16/2022 9/9/2022 9/2/2022 8/26/2022
All Loans -19 16 -37 -18
BB -3 25 -32 -9
B -27 19 -42 -21
CCC -4 -22 -55 13
2nd Lien -36 6 -7 -40
LL100 -30 14 -74 -38
Middle Market 22 23 -17 -1
Source: Source: LCD
Middle market defined as $50mn EBITDA or less. LL100 composed of the 100 largest issuers (by face value) in the S&P LCD Leveraged
Loan Index.
BofA GLOBAL RESEARCH

Primary Activity
YTD global issuance currently totals $221bn (-60% compared to YTD 2021) and $191bn
in the US (-59% from YTD 2021). September MTD new issue volume totals $13.7bn,
about 188% of July's monthly issuance of $7.2bn. A little over $4.0bn of this new
issuance is due to the Citrix deal. The composition of deals being financed by the market
MTD is 78% LBO and 21% M&A.

10 Collateral Thinking | 26 September 2022

Exhibit 18: Recent new loan issues
The largest recent new issue came from Citrix System’s $4.0bn deal
New
Launch Inst. Cov
Dt Issuer Money Moody's S&P ABL Lite Proceeds Sector Country
9/21/2022 Ontic 85 B2 B No YES Refinancing Aerospace & Defense United States
9/21/2022 TenCate Grass Holding BV 274 NR NR YES Acquisition Chemicals Netherlands
9/21/2022 House of HR 1,145 NR B YES LBO Services & Leasing Belgium
9/21/2022 House of HR 310 NR NR YES LBO Services & Leasing Belgium
9/21/2022 Generation Bridge 33 Ba2 BB- No NO Dividend Utilities United States
9/19/2022 Brightspeed 2,000 B2 B- No YES LBO Telecom United States
9/19/2022 WellSky Corp. 400 B2 NR No YES Acquisition Computers & Electronics United States
9/19/2022 Warner Music Group 150 Ba3 BB+ No YES Acquisition Entertainment & Leisure United States
9/15/2022 Inetum 400 B2 B YES LBO Computers & Electronics France
9/14/2022 Rovensa SA 387 B2 B YES Acquisition Chemicals Spain
9/12/2022 Konecta 450 B2 B+ YES Acquisition Computers & Electronics Spain
9/8/2022 Citrix Systems 4,050 B2 B No YES LBO Computers & Electronics United States
9/8/2022 Citrix Systems 501 B2 B YES LBO Computers & Electronics United States
9/7/2022 Covetrus 1,525 B1 B- No YES LBO Retail Food & Drug United States
9/6/2022 Flutter Entertainment plc 1,250 Ba1 BBB- No YES Acquisition Gaming & Hotel Ireland
9/5/2022 Accell Group NV 700 B1 B YES LBO Automotive Netherlands
8/29/2022 SAS AB 700 NR NR No NO DIP Transportation Sweden
Source: BofA Global Research, LCD
BofA GLOBAL RESEARCH

Exhibit 19: Average new issue yields by month

B new issue yields declined from a high of 8.58% to 6.27% over the month of August

16
BB B CCC
12

0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Source: LCD
BofA GLOBAL RESEARCH

Collateral Thinking | 26 September 2022 11

CLO Update
CLOs are the largest buyers of loans and today represent close to 72% of the primary
demand within this asset class. Loan retail funds have declined slightly as a share of this
market since 2020. At the same time, hedge, distressed & high yield funds have
increased their percent of this market since 2020.

Exhibit 20: Primary institutional investor market by type

CLOs make up 72% of the primary institutional market

CLO Hedge, Distressed & High-Yield Funds Loan Mutual Funds Insurance Co. Finance Co.
100%
80%
60%
40%
20%
0%
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 LTM
6/22

Source: LCD
BofA GLOBAL RESEARCH

Exhibit 21 shows CLO spread levels by tranches. After falling almost back down to pre-
COVID tights across tranches in 2021, CLO spreads recently have been increasing
against the backdrop of rate hikes and market volatilities. CLO arbitrage is a widely
followed statistic in the loan market, and represents the theoretical spread that
managers can capture by issuing CLOs. Exhibit 22 compares CLO asset (loan) spreads to
the weighted average spreads of CLO liabilities. The difference between these two
values is the theoretical arbitrage and represents the current attractiveness of creating
new CLOs. A higher arbitrage number means a greater incentive for managers to bring
new CLOs to the market, and thus provide incremental loan demand, and vice
versa. Historically, this arbitrage calculation has put more weight on the primary loan
market. Since primary activity has been notably absent in the last few months, the
recent asset spreads and thereby arbitrage looks artificially high.

Exhibit 21: US CLO 2.0/3.0 indicative spread level (bps) Exhibit 22: CLO Arbitrage (bps)
Secondary CLO spreads increased over September after declining in August CLO arbitrage has declined recently

AAA AA A BBB BB B
1,000
Loan spreads
1500 Arbitrage
800
WA CLO Liability Spreads
1000 600

400
500
200

0 0
2015 2016 2017 2018 2019 2020 2021 2022 2017 2018 2019 2020 2021 2022
Source: BofA Global Research Source: BofA Global Research, LCD
BofA GLOBAL RESEARCH Arbitrage: Loan asset spread – WA CLO spread X Liability %
Loan spreads (running avg 4wks): 60% sec BB, 40% sec B
Until 3/4/22 Loan spreads (running avg 4wks): 50%new issue B+/B, 30% pri BB, 10% sec BB, 10%
sec B
BofA GLOBAL RESEARCH

Exhibit 23 shows monthly CLO returns as defined by the Palmer Square CLO index (price
plus coupon returns).

12 Collateral Thinking | 26 September 2022

 Exhibit 23: Monthly CLO 2.0 returns by rating
CLOs returned 0.9% in August

5% AAA AA A BBB BB
3%
0%
-3%
-5%
Aug-21 Oct-21 Dec-21 Feb-22 Apr-22 Jun-22 Aug-22

Source: BofA Global Research, PriceServe, Palmer Square CLO Indices, Bloomberg
BofA GLOBAL RESEARCH

The following charts show demand trends within the loan market, correlated with
returns within rating buckets. Exhibit 24 shows a measure of retail flows (12 week
trailing retail flows as a percentage of outstanding AUM) vs. monthly BB Loan total
returns, while Exhibit 25 depicts monthly CLO issuance vs. monthly B Loan total returns.
While loans have shown positive returns over the month of August, CLO issuance
continued its decline.

Exhibit 24: BB performance vs Loan retail flows Exhibit 25: B performance vs CLO creation
12wk trailing flow % of AUM with BB rolling 12k return 12wk CLO issuance with B rolling 12wk return
30 6 10
12wk trailing flow, pct AUM 12wk CLO issuance ($bn)
BB rolling 12 wk return (RHS) 55 B rolling 12wk return (RHS)
20 3 6
40
0 2
10
-3 25 -2
0
-6 10 -6
-10 -9 -5 -10

-20 -12 -20 -14

2012 2014 2016 2018 2020 2022 2012 2014 2016 2018 2020 2022

Source: LCD, EPFR Global Source: LCD, EPFR Global

BofA GLOBAL RESEARCH BofA GLOBAL RESEARCH

Collateral Thinking | 26 September 2022 13

14 Collateral Thinking | 26 September 2022
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