May 4, 2017 / 7:14 PM / 3 months ago

LPC: US second-lien loans become first choice

NEW YORK, May 4(Reuters) - Strong investor demand is allowing US private equity firms to use increasingly large second-lien loans to maximize the amount of debt and leverage that they can raise to finance buyouts such as financial software provider Misys.

Misys arranged a US$6.2bn loan package in April to back its merger with fintech company DH Corp. The deal included a US$1.245bn second-lien term loan. This is the largest since a US$1.515bn facility for wireless venture LightSquared in April 2015 that was part of its bankruptcy exit financing.

Prior to that, second-lien loans of more than US$1bn had not been seen since 2013 when four similar deals were priced, according to Thomson Reuters LPC data.

Despite its size, Misys’ second-lien loan was successfully placed. Pricing was lowered during syndication to 725bp over Libor with a 1% floor from initial guidance of 775bp-800bp after robust demand.

Misys has highlighted good appetite for second-lien loans, which offer investors higher yields in return for a second claim over assets in the event of bankruptcy and are more flexible to repay than high-yield bonds.

“Historically, prior to (Misys), one would have said it was too big. The size of the deal sets a new benchmark for what issuers might be able to do.” said Judah Frogel, a leveraged finance partner at Allen & Overy.

US companies have issued US$9.5bn of second-lien loans in 2017 so far, showing a increase on US$1.65bn in the same time last year, LPC data shows. Second-lien volume started to rise in the fourth quarter of 2016, when US$8.59bn of loans were issued, bringing 2016’s full-year tally to US$17.47bn.

“There’s a lot of capital out there and people want to put it to work. If there’s an instrument with higher yield people are going to run to it despite higher risk,” Frogel said.

In March, real estate investment trust Capital Automotive arranged a US$690m second-lien term loan alongside a US$1.115bn first-lien term loan to back a dividend recapitalization. The second-lien loan priced at 600bp over Libor with a 1% floor.

Aftermarket auto parts provider Truck Hero Inc is in market with a US$250m second-lien loan with a US$675m first-lien loan as part of the financing for its buyout by CCMP Capital Advisers.

Although second-lien loans are riskier, investors are still seeking yield. Second-lien debt is attracting institutional investors outside of Collateralized Loan Obligation (CLO) funds, especially from firms that can buy both high-yield bonds and loans.

Second-lien loans are typically illiquid and investors prefer larger deals of more than US$500m that can be traded, the first banker said.

Some are counseling against using Misys as an example as a highly valued fintech company owned by Vista, a well regarded private equity firm.

“Not every second-lien deal can get done even in this hot market,” the banker said.

The real prospect of credit losses in a downturn can make riskier second-lien lending a binary decision as investors are choosier about credit.

“The further down the capital structure you go the more likely you’re going to be picky,” a second banker said. (Reporting by Jonathan Schwarzberg; Editing By Tessa Walsh)

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