In the third quarter, investors woke up to the realization that the world was a riskier place, and the leveraged loan market has had to adjust.
Loans sold off sharply in secondary trading in August, effectively shutting the door on new issuance. When the primary market reopened after Labor Day, there were a number of large and midsize buyouts that investment banks had committed to finance on terms that were no longer attractive. Arrangers were forced to make large concessions, in terms of price, yield and call protection, in order to find buyers.
The first few deals to clear the market in September provided a sense of what investors will put up with, and on what terms.
"The underwriting class of July was not well received in September's market, which clearly turned for the worse, and not just because of the U.S. economy, but a changing view of risk in Europe," said Leland Hart, managing director and head of the bank loan team within BlackRock's leveraged finance group.
Hart said this uncertainty made investors reluctant to put money to work. "What is the pressure to invest when the market may be down tomorrow? The opportunity cost of investing in the short term becomes effectively zero."
But while "there's been a lot of reticence to commit to deals, that's not the same thing as a lack of demand for loans," Hart said. "Every investor would tell you they have cash on hand … and are looking for the classics: adequate [covenant] coverage, spread, standard stuff. For a deal like that, you're not going to have any shortage of attraction." On the other hand, covenant "carve-outs and other things that occur when the market is hot."
This preference for higher quality was evident in three big deals that came to market in September. A $1.075 billion first-lien loan financing the buyout of BJ's Wholesale Club was initially marketed as paying Libor plus 525 basis points, with an original issue discount of 97.5 cents on the dollar, but the yield spread was widened to Libor plus 575 basis points, with an OID of 95 cents. Similarly, the $780 million first-lien portion of a facility backing the educational software maker Blackboard's buyout was launched at Libor plus 600 basis points, with an OID of 96.5-97, but it was marked down to 94-95 and then to 92. Both borrowers are single-B-rated.
On the other hand, the double-B-rated Sealed Air's $790 million term loan, marketed to institutional investors, launched at Libor plus 400 basis points, with a 1% Libor floor and an OID of 97, but ultimately priced at Libor plus 375 basis points with a 1% floor and an OID of 98.
"You can see from the difference in the way recent deals have priced what the appetite really is," said John Bell, a portfolio manager in the fixed-income group at Loomis Sayles. Bell said there was another factor working against loans like Blackboard's: "I believe it was viewed as something underwriters had to get off their books," he said. That encouraged investors to demand big concessions.
Another reason higher-quality loans are getting a better reception is that they can be marketed to banks as well. "We've definitely seen banks buying over the last month," Bell said.
Allison Bisbey Colter is a reporter for Leveraged Finance News.
