June 4, 2020 / 1:35 PM / in a month

US borrowers shun leveraged loan market as demand wanes

NEW YORK, June 4 (LPC) - Borrowers that have historically turned to the US leveraged loan market are instead looking to high-yield bonds to refinance existing loans as bank debt becomes more costly and hard to access while demand for the asset class drops.

Health insurer Molina Healthcare and food distributor Del Monte Foods raised a combined US$1.3bn in bonds to repay their term loans in May. Artificial intelligence firm Cerence followed suit raising US$150m in convertible bonds to partially repay a US$270m syndicated loan, banking sources said. Also last month, BMC Software issued US$1.35bn in high-yield bonds to fund its acquisition of peer Compuware, underscoring the attractiveness of bonds versus institutional loans.

Weakening investor demand for loans is leading companies to pay higher margins or offer debt at steeper original issue discounts (OIDs). Meanwhile, high-yield bond sales have benefitted from the US Federal Reserve’s (Fed’s) bond-buying program. The initiative seeks to ensure companies have access to capital while navigating the coronavirus’ economic fallout. At the end of May, US companies had already raised roughly US$153bn in high-yield bonds, almost 50% higher than at the same time in 2019, according to Refinitiv data.

“Most CFOs (chief financial officers) are looking at hitting the bond market regardless of the amount of time until their loans mature. This is likely to be as good as it gets for issuers,” said Tim Gramatovich, chief investment officer at fixed-income investor Gateway Credit Partners.

DWINDLING DEMAND

At the heart of the matter is the softer demand for loans from Collateralized Loan Obligations (CLOs), the single-largest buyer of new leveraged loans. With the heightened economic uncertainty as a backdrop, CLOs are wary of adding lower, Single B rated facilities to their portfolios as these loans risk being downgraded into Triple C territory, just a few notches above default, which can trigger tests within the CLO.

“In the current market, there just isn’t the demand due to the CLO engine not being that active as a buyer,” said Jim Schaeffer, global head of leveraged finance at Aegon Asset Management. “This is considerably different than when the CLO market was more active when the high demand for loans allowed borrowers to get lower pricing and more flexibility.”

Approximately 34% of US CLOs are failing an overcollateralization test partly due to an increase in Triple C rated loans and defaulted loans in their portfolio, according to a May 29 report from Bank of America.

“Borrowers rated B2 or B3 are under a lot of scrutiny and investors have little room in their portfolios for downgrades,” said Christopher Blum, head of leveraged finance for North America at BNP Paribas. “We’re seeing this shift from loans to bonds as companies that might have come to the loan market are facing these technical issues and the Fed’s support is helping the bond market.”

Spokespersons for Molina Healthcare, Del Monte Foods, and Cerence were not immediately available for comment.

SunTrust Bank led the bond deal for Molina Healthcare, banking sources said. JP Morgan arranged the transaction for Del Monte Foods. And Jefferies, KKR, and Macquarie worked on BMC Software’s acquisition financing.

Spokespersons for JP Morgan, Jefferies, Macquarie and SunTrust declined to comment. A spokesperson for KKR was not immediately available for comment.

CHANGING TUNE

Moreover, market participants expect default rates to continue rising and reckon that recovery rates in first-lien loans will decline due to economic slowdown.

“Double-digit default rates are inevitable over the next 18 months, and recovery rates will likely be half of the historical averages for first-liens,” added Gramatovich. Institutional term loan defaults tallied US$13.5bn at the end of May, the highest total since April 2014, according to Fitch Ratings.

Whether companies are refinancing term loans or seeking debt to support acquisitions, bankers are confident that borrowers will allow a shift to bonds, mainly if companies can procure a favorable yield, according to Blum.

“Some sponsors will take advantage of the bond market,” said Blum. “There will still be a robust loan market, but we expect increased issuance of secured bonds as an alternative.”

Borrowers that have tapped the leveraged loan market in recent weeks have had to pay up.

Technology firm Xperi made hefty revisions to a US$1.05bn term loan to fund its tie-up with peer TiVo Corp on Monday. Xperi used funds from its balance sheet to make up for reducing the facility by US$50m, cut the maturity of the facility by one year to five and finalized the loan at 400bp over Libor and a discount at 90.5 cents on the dollar after pitching it at 96 cents, bankers said.

And unless the CLO engine can ramp up, some are skeptical whether market players can revive a sluggish loan market.

“The high-yield market will be the go-to because going forward, the CLO machine is likely to not exist in its historical form,” said Gramatovich. (Reporting by Aaron Weinman. Editing by Michelle Sierra and Kristen Haunss.)

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