Lev loan scarcity set for Spring amid B3 credit comeback

By Laura Thompson | Reporter | laura@9fin.com

This loan market review was originally published on March 2, 2021

Demand-driven technicals in the leverage loan market are likely to continue through spring as an M&A drought and refi frenzy keeps supply tepid. A rush of new CLOs in January let loans routinely price sub-300 bps. Now, rolling into March, the market has opened its arms for select B3 credits as CLO shops look to right their returns to improve average margins.

“As undersupplied as the market looks to be right now, that’s probably going to get even worse in the next six-to-eight weeks,” said one banking source.

Hot demand from a flurry of new CLO issuance in January drove margins on single-B rated loans below Libor/Euribor E+400 bps for the first time since March 2020. In addition, OIDs are also shrinking. Responding to these technicals, the next two-month period will likely be characterised by opportunistic refinancings and small add-ons that will keep market dynamics tipped in favour of lenders. 

“This is equal to most aggressive pricings since the financial crisis,” lamented one buysider, who – like others – worries at potentially rampant mispricing of both new issues and repricings. One distressed debt advisor concurred, opining that names that in “any other credit cycle” would have faced some liquidity issue or maturity issues are able to go out in the market and fund themselves: “It’s a get out of jail free card.”

“I’m telling all the companies I’m advising to tap the leverage loan market during this pricing window,” added a second debt advisor.

Data from 9fin shows that average margins on single B-rated euro and dollar leveraged loans YTD come in at 384 bps and 356 bps respectively. January euro loans stand at E+375 bps, dragged up by Global Ship Lease’s 700 bps loan and are 353 bps without, while February tallies at 395 bps. This compares to average coupons of 410 bps and 425 bps in December and November 2020. USD leveraged loans, meanwhile, priced in low at an average of L+325 bps in January and 387 bps in February after highs of 431 bps and 425 bps in the two months prior. 

Pricing at issue is also back to early 2020 levels. Single B rated euro loans priced at an average of 99.751 in January 2021 and 99.864 in February after widening to a low of 95.833 in April 2020. Single B rated dollar loans priced at an average OID of 99.880 (January) and 99.875 (February) after printing as low as 95.750 in July 2020.

Scarcity for Spring

The primary driver for demand has been fresh CLO issuance, for which January was a hot month. A visible pipeline of chunky LBO deals at the close of 2020 and opening of 2021 encouraged CLOs to ready their warehouses. According to Refinitiv, January USD new-issues stood at $8.5bn across 17 structures, the highest volume for the month since 2013’s $8bn, albeit down from December’s $10.4bn. In Europe, meanwhile, CLO shops issued €1.2bn of new paper, above the seven-year average.

Chunky repayments have compounded the demand picture, leaving t CLOs with yet more funds to reinvest. LSE’s acquisition of Refinitiv for $27bn saw $2.3bn of leveraged loans repaid in January, while British payment processor Paysafe repaid €1bn after exiting via a New York listing. Italian firm Nexi’s €7.8bn merger with Nets returned €3.5bn-equivalent to the loan market.

Jumbo LBOs, however, have not kept apace. According to one banker, a €30bn to €35bn pipeline of jumbo deals like Asda’s €845m E+275 bps TLB and Flender’s €965m E+375 bps TLB is “pretty much done” as the M&A market, usually three months ahead of LBO deals, pauses and reloads.

“In six to eight weeks, from around May onwards, the M&A cycle will start back up in terms of financing,” the banker said. (JP Morgan, speaking with Bloomberg, estimated €300bn of dry powder currently ready and waiting to egg on M&A activity.) “But until then, it’s going to be a lot of refinancings, repricings, recaps and add-ons.” These types of deals mean much lower net new supply for leverage loan investors, keeping or even worsening technicals in favour of lenders.

How low can you go?

For a CLO’s arbitrage to work typically requires shops to earn 200 bps above their weighted average cost of debt, explains one banker: “Generally, this has been stable at around 200 bps through to 2019 – so a loan portfolio needs to offer on average around 400 bps – but that is currently more like 135 bps to 185 bps.” Routinely sub-400 bps offerings, then, complicate things.

CLOs will eventually have to either push back on pricing, take on higher margin deals or get their investors to accept lower returns, admits one buysider. Another, who only invests in CLO equity for 10%-plus equity returns, but estimates most of their peers aim for 6%-9% returns, admits to sitting out “a fair share” on recent transactions as they did not meet their return hurdle.

“As long as there is demand, margins can go lower,” said the first advisor, something that does not appear to have abated. “We’re looking at deals and the books are three, four times oversubscribed,” the first buyside lamented.

CLO issuance shows no signs of slowing down: Deutsche Bank forecasts global 2021 CLO volumes of $193 billion, including $115 billion of resets, while Bank of America nearly doubled its 2021 forecast by $80 billion to $140 billion.

At the same time, CLO shops rose to meet lenders’ flurry of refinancing and repricing activity. “They tend to move in tandem,” said the banking source. European CLOs repriced for a total of €1.7bn to take advantage of tighter liability spreads this January, according to Refinitiv data. Refinitiv puts US AAA CLO spreads at an average of 124 bps in January, with European AAA CLO spreads significantly tighter at 87 bps – roughly back to February 2020 levels.

The repricing run

Buyside and banking sources expect a coming Spring of repricing, refinancings and add-ons to keep supply tepid. Repricings in particular have boomed already as lenders look to take advantage of tight pricing, sometimes only months after initial issue. “In January there were a load of new loans to have a go at, but now [in February] it seems like we’re bogged down in pretty uninteresting repricings,” said a third buysider. Repricings occur in heating up markets as lenders look to match their margins with new market norms. Generally, lenders wait until after the soft or hard call protection, which would demand a repayment premium, has passed.

At least 19 deals totalling €31.3bn-equivalent have been issued for purposes including repricing so far in 2021. Euro borrowers chancing a repricing shaved an average of 50 bps off loans totalling €9.0bn from E+416 bps to E+366 bps. USD borrowers matched this, slimming down repriced margins on $10.0bn of loans from an average of L+388 bps to L+338 bps.

Repricings this January and February are as follows:

Note: Ranges indicate guidance. *BME’s existing €920m TLB currently pays E+447 bps, however this will step up to E+500 bps after Q1 compliance certificate reporting. **Centrient’s €335m TLB, first backing its purchase by Bain Capital, repriced from E+475 bps to either A) E+425 bps with 101 soft call for six months, 99.75 OID for new lenders and 100 for existing lenders; or B) E+450 bps at par with no soft call protection. A ticking fee of 50% kicks in at 60-days, rising to 100% after 90-days.

“It can be frustrating when a lot of what is coming across your desk is a repricing, especially if you are already bought in, but you have to take [a repricing] as a new deal,” said the second buysider. “Where else are you going to put your money right now?”

Alongside repricings, leveraged loan market participants expect a flurry of fund-to-fund transfers through 2021. Advantages to this less common acquisition process include its speed, as the sponsor avoids an auction process, meaning they can take advantage of this tight pricing window. “With pricing a bit erratic at the moment, it can make more sense to hold onto a credit you’ve got faith in than send it off to an auction process,” said a third advisor. “Especially if you think there is a clear recovery story here, but market pricing isn’t matching that.”

Netherlands-based healthcare business Mediq’s €500m E+350 bps 2028 TLB backed a sale between two Advent International funds, while German pharmaceuticals firm NextPharma’s €290m E+375 bps TLB support an internal sale between sponsor CapVestfunds. Swedish security company Verisure’s €2bn E+350 bps 2028 TLB, plus €2.2bn in bonds, saw the firm from one Hellman and Friedman fund to another.

Verisure is also an example of another demand-friendly feature leveraged loan sources expect to proliferate in the coming months: the overall €4.4bn debt package fattened up a €1.6bn dividend recap for its sponsor.

“I’m expecting more dividend recaps slipped into deals,” said a fifth buysider. “There’s pent up demand from the PE firms who put borrowing on hold in 2020 and there’s institutional investors happy to fund them given the returns profile elsewhere.” Beyond Verisure, Edilians funded a €110m dividend recap to sponsor Lone Star last week with its €685m E+350 bps 2028 TLB.  

“Books are so oversubscribed that sponsors can suggest stuff like margin step-downs and there are enough people who will take it,” the fifth buysider added.

February flies wide as B3 blooms

Coupons on fresh loans widened in February despite continued insistence that demand overweighed supply. Euro loans priced +20 bps wider to E+395 bps month-on-month. Dollar loans saw a movement roughly triple that – a +60 bps shift to L+387.5 bps.

This has been driven by a new influx of lower rated lenders as structural demand for spread products grew. After filling their coffers with tightly priced deals in January, CLO shops have cautiously reopened their doors for lower-rated credits to keep their returns in check.

“What we’ve started to see happen is repricings being accepted by B3 issuers and at times [buyers] accepting higher leverage on those credits,” explains one banker. B3 issuers were something of a no-go area in 2020 after a boom in 2018 and 2019 lead to creeping weight average rating factors (WARF) for the CLOs taking them on. Now, CLOs are selectively taking on B3 credits to offset January’s tightly priced offerings.

B3-rated issuers in February include: Solenis (B3, Moody’s), BMC Software (B3/B-, Moody’s/S&P), Zentiva (B3/B Moody’s/S&P) and Kloeckner Pentaplast (B3/B, Moody’s/S&P), with B3-equivalent lenders Atnahs (B-, S&P) and BioGroup (B- S&P) topping up the list. In January, by contrast, DeltaFiber was the sole B3-rated issuer to price (B3/B- Moody’s/S&P).

A disparity is also opening up within B3-rated credits. B3-rated Zentiva repriced its €1.275bn TLB down 25 bps to E+375 bps on February 9, 2021. Equally B3 Kloeckner Pentaplast, meanwhile, priced at E+475 bps just five days earlier.

“The loan market typically does not have such a spread between same-rated issuers, but B3 credits are showing that disparity now – which is healthy,” said the banker. “It means the market is opening up to B3 credit but still charging a premium where appropriate.”

However, given most of these deals are refinancings or small add-ons, it will be more difficult for CLOs to offset any thin-margin loans they may have taken on in January, keeping appetite for coupons above 400 bps high. The average February euro single-B coupon weighted by amount issued was 370 bps - versus a flat average of 395 bps.