Loan Investors Demand Call Protection as Returns Rise

The number of leveraged loans with call provisions has jumped sevenfold this year as investors demand protection from the risk that companies will refinance their debt with borrowing costs at the lowest in six months.

Getty Images Inc. and Dunkin’ Brands Inc. came to the market this week seeking loans that mandate they pay a premium over face value if they decide to refinance.

Call provisions, common in the bond market, were included in 147 loans arranged this year, up from 21 in all of 2009, according to data compiled by Bloomberg, as investors seek protection amid a surge in demand for new loans. Leveraged loans have rallied, with total returns on the Markit iBoxx USD Leveraged Loans Index at 9.62 percent as of yesterday.

“The call premium is a way of attracting high-yield accounts into the loan market,” said Randy Schwimmer, head of capital markets at Churchill Financial LLC in New York. “It brings liquidity into the market and gives alternative investors insurance that their asset won’t be repaid too quickly without some cost to the issuer.”

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index rose to 91.87 cents on the dollar yesterday, approaching this year’s high of 92.9 cents on April 26. Prices are up 55 percent from Dec. 17, 2008, when the index closed at 59.2 cents. High-yield, high-risk debt is rated below Baa3 by Moody’s Investors Service and BBB- by S&P.

Getty Images, the visual-content provider, is offering investors soft-call protection of 101 cents on the $1.37 billion loan facility it’s seeking, according to a person familiar with the deal. That means the Seattle-based company would have to pay 1 cent over face value to refinance the debt in the first year.

‘Cheap Way’

“When you’re trying to attract the last dollar, a call premium is a fairly cheap way to improve yield for the investor without costing the issuer anything upfront,” Schwimmer said.

Getty Images reduced the interest rate it was offering investors on the loan, which it plans to use to pay a dividend to private-equity owners Hellman & Friedman LLC and recapitalize the company, said the person, who declined to be identified because the terms are private.

The new interest rate will be 3.75 percentage points more than the London interbank offered rate, with a 1.5 percent Libor floor, according to the person. The loan is expected to price at 99 cents on the dollar. Libor is the rate banks charge to lend to each other.

The facility includes a $1.27 billion six-year term loan and a $100 million five-year revolving line of credit, according to the person. Barclays Plc, JPMorgan Chase & Co., General Electric Capital Corp., Bank of America Corp. and Goldman Sachs Group Inc. are arranging the facility.

Easier Access

Borrowing costs in the loan market are at the lowest since May, according to S&P’s Leveraged Commentary and Data, giving companies easier access to the debt markets.

New-issue spreads, including Libor floors and upfront fees, averaged 5.26 percentage points as of Oct. 21 for loans rated BB or BB-, down from 5.82 percentage points at the end of August, according to S&P LCD.

About $290 billion of U.S. leveraged loans have been arranged in 2010, compared with $170 billion in all of last year, according to Bloomberg data.

Since the end of 2009 through the end of September, about $96 billion of leveraged loans due through 2014 have matured, been paid down or extended, according to data supplied by Bank of America Merrill Lynch.

Dunkin’ Brands, owner of Dunkin’ Donuts and Baskin-Robbins restaurants, was seeking a $1.35 billion loan facility this week that included a call option, according to a person familiar with the deal.

Dunkin’ Soft Call

Dunkin’ lenders also are being offered one-year soft-call protection of 101 cents, said the person, who declined to be identified because the terms are private. Barclays, JPMorgan Chase, Bank of America and Goldman Sachs are arranging the debt.

Proceeds from the offering will be used to refinance debt and to pay a dividend to private-equity owners, said the person. Dunkin’ Brands, based in Canton, Massachusetts, was purchased by Bain Capital LLC, Carlyle Group and Thomas H. Lee Partners LP in 2006.

Declining default rates and Federal Reserve policies that have kept interest rates low have helped fuel demand for debt.

On Nov. 3, the Fed’s Open Market Committee said it would buy an additional $600 billion of Treasuries through June in an effort to reduce unemployment and avert deflation. The central bank also left its benchmark interest rate target for overnight interbank loans at zero to 0.25 percent, where it has been since December 2008.

Default Rate

“Keeping long-term rates low will continue to incentivize companies to issue debt at attractive yields,” said Darin Schmalz, a director at Fitch Ratings in Chicago. “And it sounds like the Federal Reserve is committed to keeping interest rates low for an extended period of time, which should help businesses.”

The issuer-weighted global speculative default rate fell to 3.7 percent in October from 4 percent in September, according to a Nov. 4 report by Moody’s. The global default rate was 13.4 percent in October 2009 and is expected to fall to 2.8 percent by the end of 2010, Moody’s said.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE