CLO and leveraged loan spreads are expected to remain at or near tights as credit fundamentals in the corporate sector remain robust against a backdrop of deterioration within the U.S. housing market, Bear Stearns analysts wrote last week.
Investor demand for leveraged loan credit has resulted in loosened credit standards, according to some market participants. Even so, the persistently tight leveraged loan spreads have led a number of CLO managers to pick up higher yielding assets, such as middle-market loans. But while there are some cracks in the theme of robust corporate credit performance, a number of analysts, including those at Bear Stearns, feel that the "current corporate credit cycle still has some time to play out."
All-in-all, leveraged loan issuers seem pretty healthy. Average Ebitda growth among public-filing issuers was 17.3% in the second quarter, slightly down from 20.3% in the second quarter but up year-over-year by 3.2%, according to analysts. The average debt-to-Ebitda ratio for the past two years has ranged between 4.8 times to 5.0 times. On the other hand, some of the newer leveraged buyout deals have higher-than-average debt multiples and lower interest coverage ratios - a trend investors should be wary of. "It is on the margin that investors need to be a bit more careful, as can be seen from the average leverage multiple of large LBOs that has grown to six times, and the average interest coverage for these has fallen to 1.5 times," Bear Stearns analysts wrote.
Meanwhile, the loan-only credit default swap market continues to grow, as an increasing number of investors look to hedge their bets on the vitality of corporate credit. Although speaking to the positive short-term outlook of the sector, the premium on the contracts remains "well within" the spread on cash loans, according to Bear. In other words, investors don't appear to be scrambling to short using loan CDS just yet.
Some investors have turned away from CDOs backed by residential mortgages in favor of CLOs. JPMorgan Securities has been a proponent of CLO investing "at the wings," as it has grown increasingly bearish on lower-rated tranches within the home equity ABS space and, subsequently, those CDOs backed by subprime credits.
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