Loan Valuation, Analysis & Transparency WEBINAR 1 ST JUNE AM EST

Transcription

1 Loan Valuation, Analysis & Transparency WEBINAR 1 ST JUNE AM EST

2 Agenda Welcome Ian Blance Managing Director, Voltaire Advisors LSTA Advocacy for the Loan Market Tess Virmani, SVP & Associate General Counsel, LSTA Difficulties In Pricing Syndicated & Middle Market Loans Mark O'Brien, SVP Sales & Marketing, AdvantageData Valuation of Private Illiquid Securities Jordan Barnett, Director, Murray Devine Valuation of CLO s Alvin Hsu, Vice President, MountainView Financial Solutions Audience Q&A 1100 Close of Webinar

3 3 Introduction Ian Blance Managing Director Voltaire Advisors

4 Introduction 4 Loans one of the more challenging asset classes for our asset management clients to fair value due to three key characteristics: 1. Lack of transparency loan market typically opaque in terms of trade and deal activity with many private transactions 2. Illiquidity many loans are illiquid and do not trade regularly if at all 3. Complexity loan terms can often be customized and include specialized features that need to be taken into account in a valuation This Webinar looks at some of these issues and the attempts to resolve them

5 Introduction 5 LSTA will outline their role in loan market advocacy and will briefly discuss Leveraged Loan Guidance, Risk Retention and the new Liquidity Management rules Advantage Data will review the issues in obtaining pricing data for loans, especially illiquid and middle market paper, commenting on how BDC data can help in this process Murray Devine will look at valuation of a fast growing asset class in illiquid private debt, with a focus also on distressed scenarios Mountain View Financial Solutions will wrap things up with a brief primer on the CLO market, which is especially hot at the moment with a wave of refinancing at compressed spreads Questions can be submitted throughout the sessions and will be addressed at the end

6 6 LSTA Advocacy for the Loan Market Tess Virmani Senior Vice President & Associate General Counsel LSTA

7 LSTA Advocacy for the Loan Market Tess Virmani, SVP & Associate General Counsel

8 LSTA membership includes the sell-side, buy-side, law firms, and vendors Vendors, 37 Banks, 74 Law Firms, 157 Institutional Investors, 141 8

9 Education remains a critical component of LSTA products and services Areas of LSTA staff loan market expertise Legal & Regulatory Market Analysis Operations Speaking Engagements (LSTA and third party) Conferences Seminars Webinars Roundtables Publications (LSTA and third party) Books Articles Newsletters 9

10 10

11 The LSTA has been engaged on many regulatory issues for the loan market FATCA Dodd-Frank Regulations Participations Risk Retention Volcker FDIC Assessments Reg AB And more Leveraged Lending Guidance SEC s Liquidity Risk Management Rules 11

12 What does the Leveraged Lending Guidance say? Released in May 2013 by the three banking regulators (OCC, Fed, FDIC) Banks cannot originate* non-pass credits Generally viewed as loans to companies that cannot show the ability to repay all senior debt or half of total debt in 5-7 years from base cash flows Leverage > 6x raises concerns Discomfort around the lack of maintenance covenants Casts a skeptical eye on EBITDA adjustments, incremental baskets Includes onerous reporting requirements, including for nonleveraged loans swept up into the leveraged definition *Originate means originate, refinance or modify

13 Share of LBOs (%) Debt/EBITDA (x:1) A look at the market impact of the LLG Fewer LBOs Have High Leverage But Reported and Adj. Leverage Trends Differ 70% 8 60% LBOs with Lev >=7x LBOs with Lev >=6x 7 50% 40% 6 30% 5 20% Avg Total Leverage (Reported EBITDA) 10% 4 Avg Total Leverage (Adjusted EBITDA) 0% Q17 3 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 Source: S&P/LCD Source: CovenantReview Adjusted leverage on LBO loans has stabilized/come down However, EBITDA adjustments have increased thus increasing the gap between reported and adjusted EBITDA But regulators generally happy with the effect of Leveraged Lending Guidance 13

14 Six months in, how is the CLO market coping with risk retention? Final Rule requires CLO managers (or a majority-owned affiliate thereof) to retain 5% of the CLO s notes (vertical, horizontal or L shaped) None of the industry s proposals, including the LSTA s Qualified CLO, were accepted CLO formation continues, but many CLO managers are finding that issuing new CLOs is expensive; some find that is it simply out of reach LSTA is still challenging the agencies Final Rule in court In December 2016, the DC District Court granted summary judgment to the federal agencies LSTA has filed an appeal seeking a reversal of that decision and requesting the court to vacate the Final Rule as applied to CLO managers LSTA continues to pursue regulatory and legislative fixes 14

15 The SEC released Final Liquidity Risk Management Rules in 2016 Applicable to all open-end mutual funds, including loan mutual funds Each fund must adopt and implement a written liquidity risk management program that is reasonably designed to assess and manage its liquidity risk Program must include four elements: Assessment, Management and Periodic Review of Liquidity Risk Classification of Portfolio Assets Highly liquid investments (cash and investments convertible to cash within three days) Moderately liquid investments (investments convertible to cash in four to seven days) Less liquid investments (investments that can be sold within seven days but take longer than seven days to settle) Illiquid investments (investments that cannot be sold within seven days without significantly moving its market value) Highly Liquid Investment Minimum 15% Cap on Illiquid Investments The rule adds extensive board responsibilities and reporting requirements The requirements in the final rules are an improvement to those in the 2015 proposed rulemaking. In particular, classification of assets was significantly simplified and minimum holdings of highly liquid assets was improved Loans were not categorized as illiquid investments although because of their settlement times, loan assets will likely be less liquid and that will have to be publicly disclosed 15

16 16 Difficulties In Pricing Syndicated & Middle Market Loans Mark O'Brien SVP Sales & Marketing AdvantageData

17 Difficulties In Pricing Syndicated & Middle Market Loans AdvantageData Creating a mark to market for loans is quite difficult given the lack of infrastructure surrounding the asset class when compared to other debt securities like bonds. Traditional Pricing Sources: Trades Loan Desk Quotes Trade data is sparse therefore traditionally loan vendor pricing is dependent on trading desks at major sell-side firms. Anonymous broker quotes are defensible for large, liquid loans but as the search for yield drives buy-side firms into less liquid, often direct lending of capital, the approach to data collection and pricing must adapt as these securities typically don t cross bulge bracket trading desks.

18 How To Source Data on Illiquid Loans & Direct Lending AdvantageData Engage trading desks that specialize in middle market an illiquid securities. Diversity of sources beyond the bulge bracket banks ensures any secondary activity is captured. Leverage public sources of pricing data. Buy-side historical marks are under-utilized sources of data on securities that have little to no liquidity. Mutual funds, BDCs and other vehicles that file publicly give us recent data on middle market and illiquid loans not found in vendor databases. News publications that focus on new issuance in the middle market also can be tapped for private deal data. These efforts give recent price points while also expanding the breadth of reference data. Create relevant indices/benchmarks for calibration. The inputs used to drive the pricing model should be highly specialized for each security. Utilizing indices of uncorrelated markets like middle market or direct lending will yield better results.

19 Valuation Of An Illiquid Lower Middle Market Loan AdvantageData Loan Issue: XYZ Corp - First Lien Term Loan L+650 5/1/2019 Total Principal At Issuance: $40,000, Business Description: XYZ Corp is a retailer of sports equipment in the United States. Issue Date: 5/1/2014 Broker quotes are unavailable. As with most loans of this size, we see no observations in the secondary market. We have closed-end fund marks from quarter end. Using BDC filings we find two prices for this first lien to use as a calibration point at 3/31/17 rather than our issue date over 3 years ago. Utilize specialized indices for calibration. Using data from just the lower middle market and retail industry fills in the gap since our 3/31 calibration point. Because our benchmark uses similar uncorrelated securities, we are insulated from the movement seen in larger markets.

20 About AdvantageData AdvantageData Founded in 1997, AdvantageData is a leading provider of credit and credit derivative pricing, descriptive, financial and analytical information. Via the powerful AdvantageData workstation, sell and buy-side fixed income analysts, traders, portfolio managers and risk management professionals gain access to a comprehensive global fixed income platform. The AdvantageData feeds services are likewise utilized by banks, brokers, mutual funds, hedge funds, asset managers and insurance companies for end of day valuation, research, and compliance functions.

21 AdvantageData Products AdvantageData Pricing, descriptive data and analytics across all products NORTH AMERICAN HIGH YIELD 8,100+ North American High Yield Corporate Bonds EUROPEAN HIGH YIELD 3,600+ European High Yield Corporate Bonds CREDIT DEFAULTS SWAPS 300,000+ CDS covering 6,200 reference entities GLOBAL 9,000+ Global Bonds from Europe, Japan, Australia & New Zealand TRACE Real-time pricing disseminated by FINRA TRACE covering approximately 39,600 securities EQUITIES Coverage of global equity markets included at no cost MIDDLE MARKET LOANS 3,000+ Current Middle Market Cross-Asset Investments including daily pricing, holdings & middle market benchmarks NORTH AMERICAN INVESTMENT GRADE 21,400+ North American Investment Grade Corporate Bonds EUROPEAN INVESTMENT GRADE 38,700+ European Investment Grade Corporate Bonds EMERGING MARKETS 47,000+ Corporate and Sovereign Emerging Markets Bonds CONVERTIBLE 4,200+ U.S. Domestic and International Convertible Corporate Bonds OLD BONDS 397,100+ Expired, Called and Matured Bonds across all products SYNDICATED LOANS Over 22,000 global broadly syndicated dating back to 2011 and representing over $33 trillion in aggregate volume. Coverage includes daily pricing on 4,500+ currently active secondary market loans from 600+ independent pricing sources BDC Over 200,000 historical BDC fair values assessments on senior secured, subordinated debt, equity and structured products investments dating back to 2000

22 Thank You Mark S. O'Brien SVP, Sales & Marketing Direct: (617) Cell: (617) Alex Buzby Director, Business Development Direct: (617)

23 23 Valuation of Private Illiquid Securities Jordan Barnett Director Murray Devine

24 Murray, Devine & Co. Valuation of Private Illiquid Securities US Loan Market Webinar June 2017

25 Valuation Process Review Client Information Investment memos Credit documents Financial statements Independent Source Collection Market data e.g., active market yields, quotes in non-active markets, pricing of new issuance Internal database and market participant discussions Calculation Analyze subject company Determine enterprise value Conduct debt valuation Review for accuracy and consistency 25

26 Professional Judgement Professional judgement requires a process of research and analysis to identify the appropriate facts and reach a supportable conclusion. Different conclusions can be reached for a given set of facts. Consistency difficult to maintain with large loan portfolios. Liquid Market Prices Rating Agency Reports Credit Analysis Current Market Trends Broker Quotes Discussion with Lenders Concluded Debt Valuation 3

27 Lender Survey Regular communication with lenders plays an important role in valuation process to incorporate market participant feedback on a market that is not transparent. Sample Questions How is your current loan pipeline and are you observing an increase or decrease in new proposal volumes? Have there been material changes in spreads or coupons since the prior quarter? Do you anticipate an increase or decrease in defaults over the next six months? Have you observed any material changes in deal structures related to OIDs, Fees, leverage, and covenants? 27

28 Market Yield Matrix Yield matrices derived from independent market data sources (internal and external) improve consistency and aggregates research findings. Sample Yield Matrix (For discussion purposes only) Example data points: Yields on new issuance. Segment data by facility type. Segment data by markets. Track trends of recent deals. Credit Metric Market Asset Type Leverage LTV Large Middle Small 1st Lien Term Loan A 2.5x-3.5x 35%-45% 3%-5% 5%-7% 7%-9% 1st Lien Term Loan B 3.5x-4.5x 45%-55% 5%-7% 7%-9% 9%-11% Unitranche 2.5x-5.5x 35%-55% 7%-9% 9%-11% 11%-13% 2nd Lien Term Loan 4.5x-6.0x 55%-70% 9%-11% 11%-13% 13%-15% Sub / Mezz 6.0x+ 70%+ 11%-13% 13%-15% 15%-17% 28

29 Valuation Issues: Non-Active Quotes Valuation Issue Quoted market price different from value using DCF. Due Diligence Questions How many brokers are providing a quote? Are the quotes actionable? Does it incorporate recent / relevant info? Is there sufficient info to support quote as valuation conclusion? Valuation Reconciliation Fundamental credit analysis. Selecting market yield appropriate for risk of underlying company. Reconcile two prices through further due diligence. 29

30 Valuation Issues: Example Subject Company Manufacturer 2 nd Lien Term Loan held by various funds at different prices. Valuation Issue Broker quotes inconsistent with fair value (DCF). No material change in credit profile. Further due diligence indicated quote was not actionable. Valuation Impact Different fund pricing/volatility for identical security. 30

31 Valuation Issues: EBITDA Add-backs Add-backs represent growing portion of EBITDA calculation for covenant purposes 33% of reported EBITDA through May-17. Up from approximately 22% in 4Q16. (Source: LevFin insights) Valuation Issue Concerns around quality of earnings. Favorable credit metrics at issuance. Valuation Reconciliation Borrower friendly market trend. Nature of add-back. Sensitivity to exclusion of add-back. 31

32 Valuation Issues: EBITDA Amendments Two components to consider: I. Operating income on a normalized basis. II. Sufficient liquidity to service fixed charges (principal and interest payments). Valuations are typically forward looking Restructuring/Sunk costs for store openings/merger cost saving synergies. Common industries to note: Restaurant industry. Retail industry. Use of NFY EBITDA Better indication of normalized EBITDA. How robust is NFY budget? Does the underlying company perform inline with budget? 32

33 Valuation Issues: Example Subject Company Restaurant Operator Valuation Issue Amendment to EBITDA allowing add-backs for store opening/closing expenses EBITDA does not include benefit Valuation Conclusion Consider NFY EBITDA Better understand business on a goforward basis. 33

34 Valuation Issues: Distressed Debt Fundamentals of distressed company valuation The future cash flows of distressed companies are often uncertain. Consider a liquidation value rather than a going concern value. Discussion with lenders workout group and turnaround consultants to review strategic alternatives. Consider 13-week cash flows, wind-down / divestiture plan, pre-packaged bankruptcy discussions. Challenges in distressed debt valuation Potential for a lack of distressed companies within sector to use as guideline companies. Consider alternative valuation approach: net asset value or income approach. Valuation impact A liquidation approach may be more appropriate for distressed debt valuations. Potential for a large range of values due to highly leveraged capital structure. 34

35 Valuation Issues: Distressed Debt Capital structure considerations: I. Priority of claims II. III. Asset back loans with lien on certain assets Equity holders willingness to support the business (i.e. sponsor backed borrowers) Common industries to note: Oil & Gas Brick & Mortar retail 35

36 Valuation Issues: Example Enterprise Value Determination Market approach at low multiples. Income approach, if projections available. Net asset value based on current balance sheet. Valuation Approach Waterfall based on current value and seniority of debt. If longer term, option analysis to assign value to securities with no current value. Valuation Conclusion Highly uncertain cash flow (high discount rates). Large value range. 36

37 Corporate Biography Jordan J. Barnett, CFA Director Jordan Barnett joined Murray Devine in 2007 as an analyst, learning the fundamentals and intricacies of the valuation profession. He is a Director and an active member of the firm s management team where his day-to-day responsibilities are centered on project execution and business development. Jordan serves as lead professional working across a broad range of clients, industries and engagement types conducting financial analysis, research, and due diligence related to the valuation of business enterprises, complex securities, intangible assets, corporate debt and a variety of other valuation needs related to tax planning and financial reporting. Leveraging his strong credit background, Jordan is a key member of Murray Devine s portfolio valuation practice assisting asset managers, such as BDCs and other private debt/equity funds, comply with valuation requirements under FASB ASC 820, Fair Value Measurements and Disclosures. Prior to joining Murray Devine, Jordan worked as a Portfolio Manager with Sovereign Bank, managing a loan portfolio focused on the healthcare and education sectors. He was responsible for several aspects of the underwriting process and portfolio maintenance in connection with the financing of various capital projects related to hospitals, health systems, nursing facilities, colleges and private schools. Jordan received a Bachelor of Arts degree in Economics from the University of Vermont in 2001 and a Master s in Business Administration with a concentration in Finance from Villanova University in Jordan holds the right to use the Chartered Financial Analyst (CFA) designation. 37

38 Corporate Biography Christina M. Conti Associate Christina Conti joined Murray Devine in Her responsibilities include financial analysis and advisory services relating to financial opinions, portfolio valuations, and the valuation of business enterprises and their underlying securities. Since arriving at Murray Devine, Christina has worked on various engagements across many different industries. Her focus has been on the financial analysis, research, and due diligence relating to debt and equity valuations for investments owned by business development companies, private debt and equity funds, funds of funds and hedge funds. Prior to arriving at Murray Devine, Christina worked for several years in senior financial analytical roles in Brazil for SulAmérica, a large publicly-traded insurance company and Alliance Ambiental, a waste management firm operating internationally in the oil and gas sector. Previously, she worked in the United Kingdom and United States as an investment analyst at Endurance, where she researched, evaluated, and reported on structured fixed income and long-term strategic investments in the company s internal portfolio. Christina received a Master of Science degree from Imperial College London in 2011 and a Bachelor of Arts degree in Economics from Bryn Mawr College in

39 Corporate Biography Jordan R. Birnbaum, CPA Senior Analyst Jordan Birnbaum joined Murray Devine in His responsibilities include financial analysis and advisory services relating to financial opinions, portfolio valuations, and the valuation of business enterprises and their underlying securities. Since arriving at Murray Devine, Jordan has worked on various engagements across many different industries. His focus has been on the financial analysis, research, and due diligence relating to debt and equity valuations for investments owned by business development companies, private debt and equity funds, funds of funds and hedge funds. Prior to arriving at Murray Devine, Jordan was a Valuation Associate at Grant Thornton, LLP, where he was responsible for the financial modeling of intangible assets relating to business combinations and goodwill impairment analysis for financial reporting purposes. He received a Bachelor of Arts degree in Business Administration with concentrations in Finance and Accounting from Temple University in Jordan is a Certified Public Accountant (CPA) as well as a Level III candidate in the Chartered Financial Analyst (CFA) program. 39

40 Corporate Biography Julian M. Thompson Senior Analyst Julian Thompson joined Murray Devine in His responsibilities include financial analysis and advisory services relating to financial opinions, portfolio valuations, and the valuation of business enterprises and their underlying securities. Since arriving at Murray Devine, Julian has worked on various engagements across many different industries. His focus has been on the financial analysis, research, and due diligence relating to debt and equity valuations for investments owned by business development companies, private debt and equity funds, funds of funds and hedge funds. Prior to arriving at Murray Devine, Julian was an Analyst at The Vanguard Group, where he was responsible for the pricing and valuation of various fixed income, equity, and private equity securities in Vanguard s funds. He received a Bachelor of Arts degree in Economics with a concentration in Finance from Syracuse University in

41 For More Information Jordan J. Barnett, CFA Director (267) Visit Our Website 41

42 42 Valuation of CLO s Alvin Hsu Vice President Mountain View Financial Solutions

43

44

45 Audience Q&A 45

46 Thank You! 46 Participants will receive a copy of the slide deck and a recording of the Webinar tomorrow. This Webinar is part of our VIVA program of fund valuation initiatives throughout 2017 more details can be found here: The next event is our Webinar on MBS & Securitized Credit Valuations on June 21 st

47 47 Contact Us Voltaire Advisors LLP 14 Wall Street No.1 Poultry New York London NY EC2R 8JR USA UK