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Banks bulked up on collateralized loan obligations again in the first quarter for risk management and other purposes. But new deposit insurance rules are expected to deter them from buying more.
June 17 -
The U.S. revival in collateralized loan obligations had spread to Europe -- until an American-style fight over how much "skin in the game" should be kept by CLO managers crept across the pond, too.
June 4 -
Investor demand for leveraged loans is so hot that to increase supply lenders are loosening restrictions on refinancing. It's the beginning of a slippery slope, some experts fear.
May 24
Leveraged loans had been relatively insulated from volatility in the broader credits markets, but reality is setting in.
Buzz about the Federal Reserve curtailing its bond buying, which resumed last month and grew louder last week, has caused issuers to pull the plug on the kind of opportunistic refinancings that have dominated the primary loan market this year.
Dividend recapitalizations and covenant-lite loans are also inviting more scrutiny. However, many loans in the secondary market continue to trade above par.
Commercial banks play several roles in the leveraged-lending market, including making the loans and investing in deals.
Starting with Calpine's withdrawal of its debt issue on June 5, 15 companies have withdrawn offerings of $11.2 billion. Three were pulled Monday: Beats Electronics ($650 million), LANDesk Software ($300 million) and Appvion ($200 million.)
Thirteen of the 15 pulled transactions involved either refinancings or re-pricings of existing debt. Some were partly or completely devoted to shareholder distributions.
Participants say most of the offerings were withdrawn because of the less-than-ideal market conditions, and not because of any company-specific hurdle.
"A number of these seem to have been arranged when the market was a little hotter and conditions were more favorable to issuers and perhaps the market got a little ahead of itself," said Paul Hatfield, chief investment officer at Alcentra.
He added that there were also some companies in more challenging sectors like shipping and distribution, segments that Alcentra has some concerns about.
"These industries typically have low margins and significant fixed costs, making them less suitable for leverage," he said.
There was also pushback from investors as companies were testing their luck too far.
Kenneth Kroszner, CLO analyst at Royal Bank of Scotland, said that generally the re-pricing of deals that were already in the market had cut spread, for instance, from Libor plus 450 basis points to Libor plus 350 basis points for single-B loans. Essentially, the loan market has re-priced and recently there has been push-back from investors who believe pricing got too aggressive.
None of these companies needed to issue new debt.
"These were really opportunistic transactions where companies that had debt in place were really looking for a good deal by refinancing," said Steven Fischer, head of debt capital markets, high yield at Morgan Joseph TriArtisan.
Loans, which are floating rate, tend to hold up better than fixed-rate bonds in a rising-rate environment. But the loan market is certainly feeling the pressure from the selloff in junk bonds and other high yield assets.
"Credit markets have softened in recent weeks, receding from their near all-time highs and the loan market was no exception to this," Kroszner said.
He added that with the lingering possibility that rates will rise sooner than expected, market participants have shied away from fixed income.
"There is a real possibility that asset purchases from the Fed moderate by year's end," Kroszner said. "In fact we have already seen rates increase on the back of the Federal Open Market Committee sentiment. With yields and volatility rising, there has been a shift away from credit markets."
In this softer market, aside from refinancings, dividend deals are not going to fare as well.
"I always tell my clients that if you go from a bull market to a not-so-bull market, dividend deals are the first to go," Fischer said. "It's about cutting back when rates back up and there's a little bit of musical chairs. What we're seeing is very similar to what happened in 2008 when people were rushing to exit and there was no liquidity. But all that being said, there's still a lot of money looking for homes whether it be in high grade, high yield or leverage loans."
The issue of covenant-lite loans is another example where arrangers and companies try to get the best deal. Walter Energy pulled a $1.55 billion transaction aimed at refinancing bank debt governed by maintenance covenants.
"Aside from dividend deals, covenant-lites are the worst during a bear market, but it's the job of bankers to push the envelope and to test the limits," Fischer said.
Numerous issuers already cut spread on their loans, so investors have started to say, given the current economic market conditions, that these lower spreads aren't enough.
Kroszner said that the problem with covenant-lite loans is that even if empirically they have performed well in the past, the question remains: Will this time around be different? With so many borrowers having already received them, investor push-back lies in the potential for "less creditworthy" borrowers to receive them.
If there's a silver lining, it is that investors continue to pour money into the loan market. Leveraged loan funds including ETFs pulled in $1.4 billion of new money for the week ended June 14. That was an increase from $989 million the previous week. The four-week moving average increased to $1.13 billion from $1 billion, according to Lipper FMI.
The other positive aspect is that, according to Ioana Barza, a director of analytics at Thomson Reuters, is that the secondary market for loans "remains very highly bid and given strong demand, buyers are at the ready, looking for buying opportunities."
Alcentra's Hatfield said that generally there have been a number of leveraged loan issues that have actually flexed their pricing upwards by a quarter of a percent, resulting in yields of around 5.75% in the secondary market and CLO and loan managers have been attracted to that. "Recently, some loans that were sold at 98 cents on the dollar and 99 cents on the dollar [in the new-issue market] are gaining up to three quarters of a point in the secondary, especially where they meet the CLO recovery tests," he said.
However, Fischer thinks that there has just been a lag effect given the fact that there is not a lot of transparency in loan trading data. "It's stickier, but companies pricing their deals at higher rates will ultimately reflect in secondary prices," he said.
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