Banks are boosting leveraged-loan sales to institutional investors by 55 percent even as borrowing costs rise by the most in more than a year.
Collateralized loan obligations, mutual funds and hedge funds bought $59 billion of the bank debt this year, up from $38 billion in all of 2009, according to Standard & Poor’s Leveraged Commentary and Data. The average spread to maturity over lending benchmarks for the most actively traded leveraged loans climbed 0.8 percentage point to 4.83 percentage points this week.
JPMorgan Chase & Co. and Deutsche Bank AG agreed to arrange a $2.85 billion term loan that may be the biggest high-yield, high-risk institutional acquisition loan since Lehman Brothers Holdings Inc. collapsed in September 2008, according to data compiled by Bloomberg. Underwriters are committing to finance transactions and sell pieces of the debt to non-bank lenders amid a sovereign-debt crisis that triggered the second-worst weekly loss in the loan market since March 2009.
“We expect loan issuance to grow in 2010 as investors continue to seek floating-rate assets in a rising rate environment at the top of the capital structure,” said Andy O’Brien, co-head of syndicated and leveraged finance at JPMorgan in New York.
The S&P/LSTA US Leveraged Loan 100 Index has dropped 1.39 cent since May 14 to 89.59 cents on the dollar as of yesterday, the most since the 1.83 cent decline two weeks ago.
Company borrowing costs as measured by the average spread to maturity over the three-month London interbank offered rate for the most actively traded leveraged loans have been rising from 3.44 percentage points on April 15, according to S&P LCD.
Three-month Libor, the rate banks say they pay for loans in dollars, climbed to 0.497 today, rising from record lows to its highest level since July 2009 as financial institutions become more concerned about the quality of collateral held by counterparties amid the euro region’s financial crisis.
“Prices of loans over the last few days have fallen less than bonds due to the rise in Libor and the senior-secured ranking of the loan asset class,” O’Brien said in a telephone interview.
Amid the sell-off in speculative-grade debt this week, banks arranged $1.84 billion of loans, more than twice the bond issuance. High-yield, high-risk debt is rated below Baa3 by Moody’s Investors Service and BBB- by S&P.
Junk-bond sales this week plummeted to the lowest in 2010 amid investor concern that the $1 trillion rescue package won’t be sufficient to prevent some European countries from defaulting on their debt.
Spreads on high-yield notes over similar-maturity Treasuries have widened by 1.5 percentage point to 6.92 percentage points since April 26, according to Bank of America Merrill Lynch’s US High Yield Master II Index. The cost of borrowing in junk bonds increased more than leveraged loans.
“In the last few weeks, even though loans have outperformed, there haven’t been as many paydowns from bond sales,” said Bradley Rogoff, co-head of U.S. credit strategy at Barclays Capital, the investment banking arm of Barclays Plc.
Since the beginning of 2009, companies used $118.7 billion of high-yield bond-sale proceeds to repay loans, while institutional loan sales totaled $98.2 billion, according to Barclays Capital.
“On an absolute basis, can loans detach from what’s happening in high-yield bonds? That is becoming more doubtful as we move forward,” said Oleg Melentyev, a credit strategist at Bank of America Merrill Lynch, a unit of Bank of America Corp. “If this whole situation drags on and at some point becomes more of a contagion issue, it will have systemic risk for the asset class.”
Banks were working to underwrite $16 billion of high-yield loans, compared with $1.2 billion in bonds, according to a May 14 JPMorgan report.
At least nine junk-rated companies this week negotiated with lenders or set bank meetings for an aggregate $3.98 billion in term loans to pay for leveraged buyouts or acquisitions, according to Bloomberg data.
“We expect to see continued corporate-to-corporate M&A activity as a result of increased CEO confidence, a desire to augment organic growth, and receptive financing markets for quality paper,” JPMorgan’s O’Brien said.
Universal Health Services Inc., the operator of more than 100 U.S. medical facilities, said this week in a regulatory filing that banks committed $4.15 billion in loans to back its $3.1 billion acquisition of Psychiatric Solutions Inc. and refinance existing debt.
Universal Health Review
Moody’s, S&P and Fitch Ratings said they are reviewing Universal Health for possible downgrades that would make it a speculative-grade company. Chief Financial Officer Steve Filton said in a May 17 conference call that the company plans to show rating companies a plan to become investment-grade again “over the intermediate term.”
In addition to the biggest term loan B since the Lehman bankruptcy froze the credit markets, JPMorgan and Deutsche Bank also committed to an $800 million revolving credit line for Universal Health and a $500 million term loan A, which is sold primarily to banks, a commitment letter attached to the filing shows.
“A lot of the deals that are getting done in the loan market had secured lender commitments a couple of weeks ago,” Barclays Capital’s Rogoff said. “When you already have the commitments, it’s only a matter of pricing, not a matter of getting the deal done.”
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