U.S. leveraged loan buyers undeterred by Fed, regulation
NEW YORK (Reuters) - The Federal Reserve's no-taper decision kicks interest rate hikes further down the road, yet investors still pour into U.S. leveraged loans to hedge duration risk and are willing to accept riskier terms for a share of the limited net new supply, said speakers at the 19th Annual Thomson Reuters LPC Loan and CLO Conference.
The loan market could be vulnerable if investors start to favor high yield bonds as rates rise, but there is little sign that loan demand will fall short of supply any time soon. Interest will rise, and loan products, pegged off of Libor, offer relatively secure floating-rate exposure.
Retail money keeps flooding into loan funds, marking 66 straight weeks of heavy inflows, according to Lipper data. Loan funds pulled in $1.3 billion in the week ended September 18, during which the Fed surprised the markets with its plan to keep on buying $85 billion of bonds weekly to keep rates low and boost economic growth.
Loan fund inflows accelerated over the summer on expectations that the U.S. central bank was about to reduce those bond purchases this month, keeping interest rates rising. Issuance of collateralized loan obligations (CLO), another key source of demand for leveraged loans, at $57 billion so far this year already topped last year's issuance.
The refinancing that dominated issuance in 2013 has put a lid on net new loan collateral, keeping investors and market-makers hungering for more merger activity.
At the same time, a series of overhanging regulatory proposals that could eventually make CLOs too costly for many sponsors and slash issuance, is keeping deal creation active until rules are formalized.
At the Thomson Reuters LPC 19th Annual Loan and CLO Conference in New York on September 19, half of those surveyed forecast $65 billion to $70 billion total CLO creation by year-end and 29 percent look for $70 to 75 billion.
"Current and impending regulations are having minimal impact on the deal flow, aside from possibly pushing forward some transactions before some rules take effect," said Brett Barragate, partner at Jones Day and a conference panelist. "Risk retention rules for CLOs, for example, once formalized are not effective for another two years."
In a separate poll, the vast majority expect loan fund assets under management of between $140 and $220 billion next August, compared with $142 billion last month.
"Retail could be a vulnerable component," said John Popp, managing director at Credit Suisse, noting outflows in the latter part of 2011 after the Fed signaled that it would keep interest rates historically low for an extended period.
But Popp, who spoke on a leveraged finance panel, expects steady inflows into loans given above average spreads, short duration, and credit profile. "At the end of the day, we're most concerned about being paid back, and our outlook from a fundamental credit perspective remains quite benign at present."
Conference attendees did note more risky leveraged loan features including payment-in-kind (PIK) toggles, dividend limitations and looser terms cropping up as more investors hunger for relatively higher-yielding assets.
Scott Peloso, managing director at Jefferies Finance LLC and panelist, said there is a general acceptance of more traditional high-yield terms in the syndicated bank loan market due to the larger percentage of cross-over investors into the asset class.
And while a long-awaited bump in M&A deal volume this summer has eased some concerns about the overwhelming recycled supply created by cut-rate refinancing, a return to robust pre-crash M&A is unlikely before 2015, based on a conference poll.
"Post Heinz and Dell, the M&A roster of new, large cap non-investment grade loans has been constrained, but up versus a year ago," said Popp.
(Editing By Jon Methven)
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