February 14, 2011 / 5:06 PM / 8 years ago

IFR-Investors seek return in stressed loans

(The following story appeared in the Feb. 12 issue of International Financing Review, a Thomson Reuters publication)

By Michelle Sierra Lafitte

NEW YORK, Feb 12 (IFR) - Investor appetite for US leveraged loans has pushed average bids to a four-year high in the secondary loan trading market which is encouraging portfolio managers to consider buying stressed or distressed loans in the hunt for yield.

Buyers’ attention focussed on troubled buyouts struck at the peak of the market such as Energy Future Holding TXEFHE.UL (formerly TXU) and Harrah’s Entertainment <HAMLEO.UL last week after Clear Channel Communications’ CCENR.UL announced plans to strengthen its finances.

Clear Channel Communications outlined an amendment and extension to its leveraged loan and a high-yield bond sale to tackle looming loan maturities which pushed the price of its debt closer to face value or par in the secondary loan market.

Investors are targeting the debt of other leveraged companies which are which are expected to launch similar debt restructurings in a bid to boost returns.

Stressed loans have the potential for greater capital appreciation than stronger leveraged loans as average bids in the secondary market continue to climb closer to par or 100 percent of face value.

Bids for the 100 most widely-held loans are averaging just under 98 percent of face value, according to the LSTA/Thomson Reuters LPC Mark-to-Market data.

As the potential for price appreciation diminishes, managers and investors are looking for opportunities in riskier loans trading at deeper discounts to par.

“There is still opportunity to capture price appreciation in the loan market,” said Paul Kauffman, partner, senior portfolio manager at Highland Capital.

“But with the average loan price now closer to the mid-90s versus the low 90s of a few months ago, it is harder to capture as much price appreciation as before,”.

The loans of stressed companies which amend and extend their debt in refinancings and make debt repayments offer more upside as secondary prices often soar on the expectation of increased interest margins that accompanies maturity extensions.

News of loan prepayments also drives secondary loan prices higher as investors are repaid at face value or par.

CLEAR CHANNEL SETS PRECEDENT

Buyers were keen to buy Clear Channel’s bank debt in the secondary market after the company announced what was perceived to be the first steps in repairing its debt-laden balance sheet last week.

The company’s term loan B rose to 93.75-94.25 of face value immediately before the announcement last Monday, when the company said that it would use proceeds from a $750 million bond due 2012 and excess cash to repay $250 million of its 6.25 percent notes due 2011, as well as $500 million of an existing credit facility.

Clear Channel also said that it intended to pursue an amendment that would allow for further extensions of its senior secured debt and provide greater flexibility to incur new debt.

The debt settled at 92.00-92.5 percent of face value after the market viewed the size of the note and prospective loan repayments of $750 million and $500 million too small to make a significant dent in the company’s $13.7 billion outstanding debt.

Clear Channel also said in a lenders’ call last Wednesday that it would seek to extend the maturity of its bank loan at a later date, postponing the anticipated rise in interest margin.

Energy Future and Harrah’s Entertainment’s secondary prices also rose last week as investors’ expected them to follow Clear Channel’s strategy and tackle looming loan maturities by announcing debt repayments or amending and extending their loans.

Energy Future’s term loan B2 rose around 75bp to 84.75-85.125 percent of face value. Harrah’s term loan B2 was also stronger at 94.25-94.75 percent of face value.

“As they continue to scout the market for returns, investors have been focused on buying higher beta credits and loans trading at a discount. They are also trying to identify names with near-term maturities that will eventually have to be amended and extended or refinanced via a bond deal,” said Alex Stromberg head of US par loans trading at Barclays Capital.

REFINANCING NO PROBLEM

Despite the relative scarcity of heavily discounted names with significant upside potential in the secondary market and yield erosion stemming from tighter spreads and the shrinking of Original Offer Discounts in the primary market, returns in the loan asset class remain attractive at 7 percent and are outpacing other asset classes.

“When investors consider that loans are floating rate, secured, at the top of the capital structure and they look at the other opportunities to earn yield in this current environment, whether it is investment-grade, emerging market debt or other fixed income alternatives, 7 percent for the overall loan market is still a very attractive return,” Kauffman said.

Bankers are concerned that yield erosion in the refinancing round could push crossover investors into high-yield bonds, but the number of new strategic investors and those increasing their allocations in the bank loan space is still growing.

Retail investors — the primary source of new inflows — poured $5.9 billion into loan mutual funds in January, topping the short-lived record of $3.3 billion from December 2010, according to Lipper FMI.

Clear Channel’s $15.7 billion loan initially attracted buyers’ interest in December 2010 and January and traded up on rumours that the company would soon announce a debt restructuring.

The loan backed the company’s LBO by Bain Capital Partners and Thomas H. Lee Partners and consisted of a $2 billion revolving credit, a $1.115 billion term loan A, a $10.7 billion term loan B, a $706 million term loan C and a $1.125 billion delayed draw term loan.

Reporting by Michelle Sierra Laffitte, editing by Tessa Walshmichelle.sierra@thomsonreuters.com; 646 223 8592

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