RLPC: Loan investors hungry despite record issuance

NEW YORK, March 7 Fri Mar 8, 2013 1:01pm EST

NEW YORK, March 7 (Reuters) - U.S. leveraged loan issuance in the short month of February leapfrogged the prior record monthly high set six years ago. But investors still hunger for an unlikely surge in new money deals that M&A and leveraged buyouts could spawn.

Total issuance topped the prior peak by 30 percent. The composition shifted, however, from an LBO-driven 2007 spree to a refinancing and repricing spurt as issuers cash in on rock-bottom borrowing costs.

February volume spiked to about $156 billion, versus $118 billion in March 2007, Thomson Reuters LPC data show. Refinancings and repricings accounted for 80 percent of last month's torrid issuance, in stark contrast with 43 percent in March six years back.

Investors have pent-up cash with slim chances that a couple of recent massive U.S. transactions will trigger a chain reaction, investors and syndicate heads said.

"Heinz and Dell are mega deals, but we're not hearing of a lot of other mega LBOs - it's not 2007 all over again," while demand is lofty, said Joseph Lynch, co-portfolio manager of the Neuberger Berman Floating-Rate Income Fund.

"With yields and total return outlooks so similar to high yield we're seeing investors look to loans from a relative value perspective," said Lynch, who expects February's overall volume could represent a peak. "People are also afraid of a move in interest rates and are more duration-sensitive, and therefore loans also look attractive to investors."

Investors could come up short if February's supply ratio persists, and deal recycling far overshadows new money loans. The pace has tapered off, but refinancing and repricing candidates remain with most loans trading above par and interest rates staying low, syndicate sources said.

Fed Chairman Ben Bernanke's congressional testimony late last month stoked optimism that interest rates won't suddenly spike, with little impetus to pull the rug out from under a nascent economic rebound.

"February was a unique month in terms of loan issuance given repricing activity, but we've already started to see things slow down a bit" said Kevin Sherlock, head of loan and high yield capital markets at Deutsche Bank. "We continue to hear frustration from sponsors about the lack of an auction calendar," however, he said. "Investors have ample dry powder to put to work. If we don't have new issue activity to sop it up, that capital gets invested in the secondary market and pushes yields lower, allowing for more aggressive deal terms."

There was some investor pushback to those terms, spurring issuers including Serta/Simmons and MGM Resorts to pull repricings.

"Pure new financing has not been prominent," but started accelerating toward month's end, added John Cokinos, co-head of leveraged finance at Bank of America Merrill Lynch. "Now with all of the new money being raised, it's putting pressure on repricings and the market is coming back to equilibrium."

SHRINKING SUPPLY

Outstanding loan issuance is rising, but because the vast majority of this year's loans simply replaced higher-cost issues, the overall market remains smaller than before the crisis.

The Loan Syndications and Trading Association said institutional loans outstanding have risen to about $550 billion from $500 billion in 2011, and below $600 billion in 2008.

About $5 billion flooded into bank loan mutual funds in February, including two record-setting weeks, according to Lipper FMI data. Inflows of about $8 billion this year through February 27 compare with around $12 billion for all of 2012.

Collateralized loan obligation issuance reached $16 billion in the first two months, providing another ready demand source.

Still, without huge U.S. M&A and LBO deals on the heels of Dell and Heinz, "it's not as if any of our investors are saying there's enough new issuance to suck up the cash," a bank syndicate source said.

Seventy-six LBO loans that were at least $500 million closed last year, 36 of them in the fourth quarter, as many tried to beat the expected tax-rate increase, said Tom Cole, Citi's co-head of U.S. leveraged finance. The number of new LBOs in the pipeline is relatively light, as a result, though Dell and Heinz will elevate financing volumes.

"Heinz and Dell are unique, as they have significant equity providers from sources other than private equity," said Cole. "I do think it is likely we will see a pickup in deals between $5 billion and $10 billion in total value."

Neuberger Berman's Lynch said the fund is more conservative with spreads tight and light new money issuance, focused on companies with hard assets, variable cost structures and liquidity access.

"We've seen an uptick in the number of smaller issuers that have come to market and in our opinion those businesses carry more risk than a large corporate and they should be coming with a meaningful yield premium, and we're not seeing that," said Lynch.