Moves by banks and mutal funds as well as other market factors are allowing a long list of issuers such as Denny's, Solutia, Petco and DineEquity to reprice their debt at cheaper rates.
The primary losers are investors in the debt offerings, who pay the price in lower returns.
According to Barclays, issuers that have recently repriced loans have, on average, been able to knock 104 bps off of their coupon. And when you take the reduction of Libor floors into account, the savings for issuers jumps to an average of 151 bps. Interestingly enough, Barclays also notes that repricing transactions have underperformed the Barclays Capital Performing Loan Index by approximately 2.3% so far this year.
"While we are not negative on the asset class given the strong demand technical, we think that the upside in leveraged loans has been greatly diminished and that investors may want to rotate out of likely loan repricing candidates," Guatam Kakodkar and Bradley Rogoff, two Barclays analysts, wrote in a recent report.
Smaller coupons and lower floors aren't the only factors. Banks are shopping most of these repriced loans without a discount, something that seemed nearly impossible this time last year.
"But even better, most [repricings] are coming with covenant reductions or even eliminations," a New York-based loan investor quipped. "Every phone call or e-mail from a salesperson is simply changing an existing deal to pay you less for the same or more risk. Good times!"
Of course, refinancings represent a fundamental part of the loan market, and issuers, like anyone with a loan, can't really be blamed for attempting to lower their rate at some point during the life of the loan. But many of the deals in the current batch — which investors refer to as repricings rather than refinancings due to their short life-span — were done in the fall, barely leaving enough time for the ink to dry on the credit agreement.
Moreover, another trend popping up in these loans is the six-month, 101 soft-call premium, which leaves the door open for the issuer to seek another repricing by summer. The norm for the loan market until very recently has been one-year, 101 soft-call premiums, and even soft-call protections that start at 103 in the first year and step down each subsequent year.
Some investors, though, are taking the repricings in stride. "Coming back from the recession there is upside, but most of the time loans are about earning the coupon," said a Boston-based investor. "Loans are built to act this way. The coupons that are being offered are still historically attractive even before floors, but with floors are even more so. Plus, the actual negative performance drag in the short term tends to be slight — a loan offered at 101.25, for example, reprices lower and trades up and is offered at 101, for example. The same high demand that drives the repricing drives the bid up above par again."
He added that for portfolio managers, there's a silver lining, because as newer loans reprice the disparity in value versus pre-2007 loans narrows, helping older loans get closer to par. "The 'upside' is what remains in B3/B- and lower-rated loans, but whether some of those loans will ever get back to par is an open question."
Strong demand, of course, is creating issuer-friendly conditions on the loan primary market. And significant new demand has come from mutual funds.
Year-to-date, loan mutual funds have taken in more than $6 billion, almost half of the $14 billion that flowed into the market during all of 2010, according to Lipper FMI and Barclays. That brings the total assets under management to $48 billion.
Market participants have diverging views on how long this repricing party will go on.
"I think the repricings will continue apace because there are banks that want to buy and agents that can make money from fees for helping CFOs reduce their borrowing costs," said a California-based investor.
The Barclays analysts, meanwhile, think the party is dying down.
"Given the percentage of loans trading above par and the subsequent potential for repricing, we believe most of the price appreciation expected for 2011 has already occurred," the analysts said. "Investors should be wary of loans trading over par and consider screening for potential candidates. Given the limited upside for call-constrained loans trading over par and the potential downside risk of repricing, we think investors should consider selling loan repricing candidates."
