Loan Prepayment Fees Offer Refinancing Protection, Barclays Says

Investors concerned about speculative-grade borrowers lowering interest rates on their loans are shielded by the adoption of prepayment fees on new deals, according to Barclays Plc.

Issuance of leveraged loans, which soared in 2013, was backed by a prepayment level of at least $101 on the dollar on 93 percent of deals, Barclays strategists led by Brad Rogoff and Jeffrey Meli wrote in a report today. That compares with 60 percent in 2010 and about 20 percent of the new-issue market in 2007, the analysts wrote.

More than 80 percent of junk-rated loans, buoyed by record deposits into funds that buy the debt, are trading above par, exposing investors to refinancing risk. The floating-rate debt, pegged to benchmark rates, seldom trades much above face value due to weaker call protection relative to junk bonds.

“Structural changes from the soft demand period post-crisis provide modest upside for new issue loans,” the analysts wrote. “This prepayment cushion has somewhat insulated loan investors from prepayment risk.”

The news isn’t all good with a higher concentration of deals prepayable at $101 after just six months of the deal, according to the report. Call protection for more than a year exists on 53 percent of the loans, while the share of debt with a prepayment fee of greater than $102 has dropped to 5.5 percent from 8.5 percent in 2012.

Excluding repricings, loan issuance surged to $373 billion compared with $167 billion in 2010 as the market began to open up after companies were shut out of credit markets because of the financial crisis, according to Barclays.

The average price of loans on the Standard & Poor’s/LSTA Leveraged Loan index climbed to 98.67 cents on Jan. 22, the most since July 2007. Leveraged loans and high-yield, high-risk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

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