February 8, 2019 / 4:57 PM / a year ago

US loans face liquidity drain as investors fly to quality

NEW YORK, Feb 8(LPC) - Nearly US$20bn of outflows from retail loan funds since late 2018 have drained liquidity out of the US leveraged loan market and are helping increasingly selective investors to demand better terms and pricing amid a rising supply of new loans, reversing the aggressive borrower-friendly market conditions of 2017 and 2018.

The US market has seen US$19.5bn of outflows from retail loan funds in the 12 weeks since November 22. December set a new monthly record of US$15bn, according to LPC data, as a growing chorus of regulators identified the leveraged loan market as a possible systemic risk in a late credit cycle environment.

Investors rushed to buy floating rate loans in 2017 and 2018 to hedge against rising US interest rates, but the pace of interest rate increases slowed in late 2018 in response to wider market volatility. A subsequent pricing correction made higher-yielding assets, including high-yield bonds, more attractive again.

Loan funds saw US$742.2m of capital pulled last week, in the twelfth consecutive week of outflows. Investors are dragging their feet on credit decisions while they evaluate better relative value prospects elsewhere in credit as the market continues to digest December’s drama.

“The market is picking and choosing,” a banking source said. “Why go with the lower rated deal when there are other higher rated deals in the same sector?”

A US$3.66bn term loan backing debut issuer and healthcare information technology company anthenahealth Inc’s buyout by Veritas Capital and Evergreen Coast Capital wrapped up February 6 after commitments were initially due February 5, as reported. This is the largest M&A-related loan of the year.

The B3-rated loan priced at 450bp over Libor, which was on the tight end of guidance after some investor friendly structural changes such as extending soft call protection to a year from six months were added. However, the price of 450bp over Libor was considerably higher than where similarly rated deals priced toward the end of last year. The US$5.5bn loan backing Refinitiv’s buyout by private equity firm Blackstone, for instance, priced at 375bp over Libor in September.

Telecommunications equipment maker CommScope managed to finalize pricing on a Ba1-rated US$3.2bn loan at 325bp over Libor, at the tight end of guidance in a 325bp-350bp over Libor range and also narrowed the discount to 99 from 98. The deal backs the company’s purchase of set-top box manufacturer Arris.

CommScope, a frequent loan market issuer, still cut the size of the loan by US$750m and increased a senior secured notes offering by the same amount to get the deal over the line, as investors are currently favoring higher yielding bonds over loans.

A portfolio manager at a Collateralized Loan Obligation (CLO) fund said that analysts are having to choose which deals to focus on in the current wave of transactions, and are being particularly selective in active sectors, such as healthcare, where there are several deals to consider.

New deals for well-known loan issuers are being received better than deals for new companies that lack established borrowing track records and credit stories.

“If you look at the deals that have gone well, they’re the deals where investors have an existing relationship,” a second banking source said. “Deals where there isn’t a history aren’t being received as well, especially if there are any kinds of questions on the credit.”

JP Morgan is leading both deals and declined to comment. TWO IN A MILLION

The athenahealth and CommScope deals are just two of a handful of US$1bn plus loans to hit the market in the last several weeks as supply has surged in the New Year, despite weak market conditions.

Outflows have been exacerbated by persistently low secondary prices after a slump in December closed the market at the end of the year. LPC’s index of the 100 most heavily traded loans sank to a multi-year low of 94.57 during late December after hitting 98.91 in early October.

Deals included a US$2.53bn loan supporting financial data provider Dun & Bradstreet’s buyout by CC Capital, Cannae Holdings, Thomas H. Lee Partners and Black Knight Inc and a US$1.65bn term loan backing home and community-based health services provider Brightspring Health Services’ merger with PharMerica.

Prices recovered in January to a high of 97.05 on January 9 and was at 96.86 on February 6. So far this year, leveraged volume totals US$49.8bn, down 36% from last year at this time when volume totaled US$77.6bn.

Bankers and investors are welcoming the volatility and are grabbing opportunities as issuance windows open and close swiftly, in what a banker characterized as a “rent it not own it” kind of rally.

“We expect more volatility in the broader market,” a third banker said. “If you see a good window, hit it.”

Several big redemptions have given investors money to spend on large new deals and are helping to offset some of the outflows, as demand for loans is also being supported by new CLO issuance.

For instance, aerospace components maker TransDigm last week sold US$3.8bn of senior secured notes that will be used to buy back term loan debt. Payments processor First Data is expected to pay down approximately US$7bn of term loans shortly as its debt is refinanced in conjunction with its acquisition by investment-grade payment processor Fiserv.

“That’s a lot of weeks of negative flows taken care of,” a fourth banker said.

Additional reporting by Leela Parker Deo. Reporting by Jonathan Schwarzberg; Editing by Tessa Walsh and Michelle Sierra

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