NEW YORK (Reuters) - Traditional banks and alternative lenders are still underwriting highly leveraged US loans despite regulatory scrutiny as red-hot investor demand shows no sign of abating and new buyout loans remain scarce.
One third of buyout loans had leverage of more than 7.0 times in the first quarter of 2017, according to Thomson Reuters LPC data, despite US leveraged lending guidelines that were introduced in 2013 to curb market risk by subjecting loans with leverage of more than 6.0 times to greater scrutiny.
This is the highest leverage level since 2014, when 40% of deals were highly leveraged. Only 2007 saw higher levels, when 53% of buyouts had leverage above 7.0 times before the financial crisis, the data shows.
Alternative lenders such as Jefferies and Nomura and direct lenders such as business development companies from Ares Capital and Golub Capital are still able to offer higher leverage, however, as they are not subject to the guidelines, which is boosting average leverage levels.
Traditional banks are still able to lend with higher leverage if they are able to satisfy regulators’ criteria. According to Jefferies data, 90% of deals with leverage of more than 6.0 times had a regulated bank on them in 2016, which rose to 91% in the first three months of 2017.
“Hot markets tend to provide issuers and sponsors a higher margin of error, allowing them to get aggressive in their interpretation of EBITDA with seeming impunity,” said Michael Terwilliger, a portfolio manager at Resource America.
High leverage levels are not stopping investors from buying deals, as the prospect of interest rate increases continues to boost appetite for higher yielding floating rate senior loans.
B3/B rated insurance brokerage firm USI Inc is in the market with a US$1.795bn term loan supporting its buyout by private equity firms KKR and Caisse de dépôt et placement du Québec which has leverage of just above 8.0 times, according to Moody’s.
Banks are comfortable that the deal will be accepted by regulators as the company has a track record and is a known issuer and are viewing leverage as around 6.5 times after adjustments, a lender said.
The term loan, which launched March 29, is being guided at 325bp over Libor and is being led by Bank of America Merrill Lynch with KCM, Citigroup and Macquarie.
Software company CCC Information Services’ recent US$1.475bn leveraged loan also had high leverage in the 7.5 times area, a banker said, while Moody’s estimated leverage in the mid-8.0 times range. The deal, which included first- and second-lien loans, was led by Jefferies and Nomura, which are not subject to the federal leveraged lending guidance.
Despite higher leverage levels, the company was able to increase a first-lien term loan backing its buyout by Advent International to US$1bn from US$925bn on March 30. The company, which is rated B3 by Moody’s, was downgraded to B- from B by S&P during syndication after increasing the loan boosted leverage to 10 times, according to the agency.
CCC Information Services was also able to tighten pricing on the deal to 300bp over Libor from guidance in the 325-350bp range and also priced a US$375m second-lien term loan at 675bp over Libor after pricing circulated in the 700bp-725bp range.
“Software deals are typically able to support higher leverage due to stability of cash flows, but it’s a bit eye popping,” said one of CCC’s previous investors who was unsure whether to lend in the new deal. “(The) new deal is twice the leverage, same spread. Ugh!”
B3-rated data center operator Cologix was able to price a US$360m loan at 300bp on March 10 at a pricing level not seen by the market since 2007.
US leveraged loans are continuing as investors buy floating rate loans to hedge against further interest rate rises. Last week was the 21st consecutive week of inflows as demand continues unabated. Strong investor demand is expected to encourage regulated and non-regulated arrangers to keep producing highly leveraged loans, another banker said.
“There is still plenty of active demand, and there doesn’t seem to be an immediate impetus to slow things down,” the banker said.
Bank of America Merrill Lynch and Jefferies declined to comment.
(Additional reporting by Davide Scigliuzzo.)
Reporting by Jonathan Schwarzberg; Editing By Tessa Walsh and Jon Methven