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Demand is outpacing supply in the leveraged loan market, which means issuers are obtaining less costly credit at the expense of investors in the loans. However, the tide is poised to turn, perhaps in the second half of the year.
February 24
It's early in the year, and optimism about leveraged loan markets has been dashed before —but this time the trend may stick.
Institutional loan investors are beginning to see more deal prospectuses related to M&A and leveraged buyouts landing on their desks. Financial players like Credit Suisse Group (CS), Deutsche Bank (DB) and JPMorgan Chase (JPM) sponsor these transactions, in which investors buy interests in loans made to corporate borrowers for merger and LBO purposes.
Acquisition financings now make up 38% of the institutional loan calendar, and LBO deals comprise another 16%, according to Thomson Reuters LPC. Refinancing and dividend recap deals make up the rest of the pipeline. Leveraged M&A issuance, excluding LBOs, has already reached $44 billion year to date, compared with $54 billion seen in all of 2011, according to Thomson Reuters.
"We definitely have seen a significant uptick in M&A activity," said Jeff Cohen, co-head of U.S. syndicated loan capital markets at Credit Suisse. "Our underwriting committees are as busy as they have been at any time since the financial crisis."
Does all of this sound familiar? It's certainly not the first time in recent memory that market participants have predicted an uptick in M&A loan activity, or that a new cycle has been put into motion for that matter.
Indeed, more than once last year, M&A and LBO deals started to build, until something killed the momentum —the global economic meltdown following Japan's earthquake and tsunami in March, the U.S. budget showdown over the summer and the European debt crisis (again).
This time, however, market participants feel more confident that the M&A trend has some staying power.
"There's more optimism in terms of the macro-economic outlook," said Richard Farley, a partner in the leveraged finance group at Paul Hastings. "The longer the European troubles drag on, the more confidence the market has that people have protected themselves appropriately. No one's going to get caught by surprise is the view now as opposed to a year ago."
In addition to this change of heart, several other necessary elements have emerged to provide the right environment for M&A and LBO deals, market participants say. These include low-cost financing, able buyers and willing sellers.
"All those things exist today, and one of the reasons why you might have willing sellers is that we're expecting slow [economic] growth," a Boston-based loan investor said. "So people who might have been holding on, I'm-not-going-to-sell-at-the-bottom types, are probably a little more willing to make that transaction happen. And the way the loan market has been behaving in the last few weeks to months is: coupons are getting tighter, terms are getting easier, and anything that's genuinely available gets bought pretty easily."
On the topic of buyers, Cohen added that, until recently, private equity sponsors were grappling with the purchase prices and multiples necessary to pry away assets from sellers under the constant threat of volatility.
"They thought borrowing costs could become extremely high, and they had to have a very strong conviction about the growth prospects of the company they were buying," he said.
In recent weeks, a spate of leveraged acquisition deals have hit the market including Hologic's $3.7 billion acquisition of Gen-Pro, and SXC Health Solution's $4.4 billionacquisition of Catalyst Health Solutions.
Of the M&A deals on the market so far, investors say they have been priced and structured pretty fairly. And that the market is still balanced enough to see a bit of investor push back from time to time.
In the first quarter, a thin forward calendar fueled reverse flexes on a substantial portion of the loan pipeline for credits across deal purposes, according to Thomson Reuters.In February alone, there was almost $8 billion in institutional issuance which saw spreads tighten amid oversubscription and strong investor demand (compared with less than $4.8 billion in upward flexes). In March, this was followed by almost $6 billion in reverse flexes (compared with just over $4.4 billion in upward flexes).
The trend later reversed itself as new money deals increased. Less than $1 billion of institutional loan volume in April, and $800 million in May, were reverse flexed (compared with almost $5 billion of upward flexes in April and an additional $2.3 billion so far in May). Refinancings for Sophos and Bausch & Lomb, among others, saw pushback and rejiggering.
That said, market participants pointed out that leverage has been creeping up on acquisition deals, for the right credits, to the 6x level or even 7x.
"I'd say up until recently we weren't comfortable going to 6.5x leverage," Cohen said. "I think now for the right business … we think these higher leverage levels work."
Farley agrees, and adds that equity checks have gotten smaller in some cases, "dipping to 25%, from an average of 30% to 35%, depending on what banks are willing to commit to."
