Borrowers Take Charge of Leveraged-Loan Marketby
Issuers reprice after hunger for yield meets an empty pipeline
‘Not a whole heck of a lot we can do about it,’ say investors
Investors clamoring for yield at the mouth of an empty leveraged-loan pipeline are giving companies like Petco Animal Supplies Inc. and grocer Albertsons Cos. the upper hand. That’s allowing them to slash their borrowing costs just months after issuing the debt.
Petco and Albertsons are among at least 20 companies that have asked lenders to let them reduce interest rates on $28.3 billion of loans in the past month. The repricing surge is playing into the hands of issuers, which can demand rate cuts from their creditors who have little choice other than to comply. Unlike junk bonds, loans are relatively easy to prepay, giving borrowers the option to refinance with new a group of investors.
For buyers looking to put capital to work, that means accepting the new terms, even if the market is delivering its lowest returns since February.
"There’s not a whole heck of a lot we can do about it because we don’t control the broader supply-demand dynamics in the market," said Chris Remington, an institutional portfolio manager at Eaton Vance Corp., which oversaw $315 billion of assets as of March 31. "You get the same risk and you get less return."
Companies have found a window to renegotiate their rates because they know that investor demand for loans is relatively strong, giving them good bargaining power when they ask their lenders for lower rates. Issuance of U.S. leveraged loans has dropped 18 percent so far this year from the same period last year, and the pipeline of future deals remains thin.
At the same time, about $690 million flooded into loan funds in May, the most on a monthly basis this year, according to fund flow data compiled by Wells Fargo & Co. and Bloomberg. Money flowed out of the funds for six consecutive weeks from mid-March through April. Before Pabst Brewing sent its creditors the request last month, there hadn’t been a repricing in the U.S. loan market since October.
Petco is seeking to reduce its borrowing expense on $2.5 billion of loans that it originally issued in January to finance its acquisition by CVC Capital Partners and the Canada Pension Plan Investment Board. Back then, investor wariness toward highly leveraged companies caused many underwriters to shelve deals or sell debt at steep discounts to get them off their books, and Petco was forced to offer higher yields to sell the two loans.
Now, Petco is hoping to lower the rate on a $1.82 billion term loan by as much as 1 percentage point. The loan currently pays 4.75 percentage points over Libor. It’s also hoping to cut the rate on a $698 million second-lien loan by the same amount.
Because loans are relatively easy to prepay -- lacking the call protection that junk bonds have -- loan borrowers have the option to refinance with new a group of investors whenever loan prices start to rise. About 15 percent of leveraged loans were trading above face value, or where they were issued, as of May 25, according to data compiled by Markit. In February, fewer than 1 percent of North American institutional loans traded above par.
"When that happens, it’s a natural thing for the borrowers to take advantage of the opportunity to reduce interest costs," said Jonathan Insull, a New York-based money manager at Crescent Capital Group LP, which oversees $19 billion of speculative-grade debt. "Loans don’t have the same kind of call protection that you’d have on a high-yield bond. It’s by design."
Albertsons lowered the rate this month on a $1.15 billion loan it raised in December to 3.75 percentage points more than Libor from a margin of 4.5 percentage points.
The flurry of loan repricings has eaten into loan returns, with syndicated loans of speculative-grade borrowers gaining 0.6 percent last month, the least since February, and down from 2.3 percent in April, according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index.
Investors are treading cautiously.
Given the trend toward repricings, investors have become “more hesitant” in buying into loans that are trading above par without call protection, despite having cash to put to work, Joan Farrell, who is on the loan sales desk at Citigroup Inc., wrote in a note to clients last month.