| NEW YORK
NEW YORK May 9 The significant supply and
demand imbalance that has largely defined the U.S. leveraged
loan market for the last two years, with unrelenting investors
chasing too few deals and driving yields lower, may finally be
finding an equilibrium.
On the heels of 95 straight weeks of record inflows into
bank loan mutual funds, retail investors reversed course in
early April, marking the first outflow in nearly two years. At
the same time, the long awaited rise in new money dealflow is
finally materializing. Together, the tempering of excess
liquidity and the emergence of new paper is taking the edge off
what has been an overheated market.
The consensus is that this cooling off does not constitute a
market correction or fundamental shift, but rather a rebalancing
back to the natural ebb and flow of supply-demand dynamics
between issuers and lenders. Lenders are getting choosier and
issuers are altering some terms to comply with investor demands.
"I think things have been brought into balance," said Jon
DeSimone, managing director at Sankaty Advisors.
In or out
Beginning the week ended April 16, bank loan mutual funds
recorded three consecutive weeks of outflows followed by a
modest $68.6 million in inflows the week ended May 7. During
that three week period retail investors extracted more than $900
million in cash, though it is worth noting that the pace of
retail demand was already slowing as evidenced by more moderate
weekly inflows before turning negative.
At the same time, increasingly robust collateralized loan
obligation (CLO) issuance has anchored demand on the
institutional side, offsetting the negative retail flows. CLO
volume stands at $38.3 billion year to date, with CLO formation
expected to remain strong through the remainder of the year.
This is up from $33.26 billion a year ago.
On the supply side, a growing pipeline of new money deals,
buoyed by a hefty lineup of M&A transactions, is also a welcome
reprieve for investors weary from the torrent of opportunistic
refinancing and dividend recapitalization transactions that hit
their desks in 2013 and early 2014.
"We've got in the pipeline Charter, Safeway, Zebra Tech,
Post/Michaels and Gates LBO. It's going to remain busy, and it's
going to remain a lot of new money supply, so I think it's going
to be more of a balanced market," one leveraged banker said.
M&A on the way
M&A and LBO deals currently comprise roughly 43 percent of
the institutional leveraged loan pipeline, which stands at
approximately $60 billion, according to Thomson Reuters LPC
data. That volume does not include forthcoming
acquisition-related contributions from issuers Charter
Communications and Valeant Pharmaceuticals.
The scaling back of the retail bid has brought some relief
from the excess liquidity flooding the market in search of a
home, said one institutional investor, comparing the tempering
effect to tapping the breaks.
The resulting smaller pool of capital and uptick in new
money supply means investors are now able to be more selective
in how they put money to work. Loan buyers have more choice,
investors noted. No longer under pressure to buy any deal at
ever lower pricing with increasingly aggressive terms and
deteriorating structures, investors are pushing back on credits
or deals considered to be more risky.
Lenders are primarily asking for more spread, as well as
higher amortization or the addition of covenants and other
investor protections to get certain deals over the line. Since
the beginning of May, a dozen issuers have flexed spreads up,
while only one has cut pricing.
At least three proposed deals have also been shelved due to
market conditions. Software development firm Rocket Software
withdrew a proposed $725 million covenant-lite loan to refinance
existing debt and fund a dividend to financial sponsor Court
Square Capital. Apparel manufacturer Dutch LLC and specialized
acute care provider Capella Healthcare pulled $200 million and
$585 million refinancing efforts, respectively.
In the last couple of years, the greatest drivers of
liquidity have been mutual funds and resurgent CLOs. In search
of yield and seeking exposure to rising interest rates, retail
and institutional money alike piled into floating-rate leveraged
loans, pressuring yields to dramatic lows.
Now upward pressure on pricing is sending yields higher
quarter to date. So far in 2Q14 the average yield on first-lien
institutional term loans is in the 5.18 percent context, up 46bp
from 4.72 percent in 1Q14.
The CLO machine is widely expected to continue chugging
along in 2014 suggesting CLOs will likely remain a significant
and stable buyer of leveraged loans. The retail bid is more
"The unknown is retail. Loans have penetrated the retail
investor base, and they may now have the allocation they want.
Whereas before they didn't have it and were adding the exposure
to their portfolios," said DeSimone. "Now it will depend on the
relative attractiveness of loans to other asset classes."
(Editing By Lynn Adler and Jon Methven)