NEW YORK, March 7 (LPC) - A limited supply of US leveraged loans looks likely to ensure a strong reception for a US$5.45bn loan which is part of a US$10bn financing package backing the buyout of Johnson Control’s auto battery unit, Power Solutions, despite more than US$15bn of outflows from loan funds in recent months.
Bankers expressed concern about the jumbo transaction late last year when investors started to withdraw money from retail loan funds, after the Federal Reserve indicated that interest rates would not rise as quickly as anticipated. This made other instruments, including bonds, more attractive on a relative value basis, and secondary loan prices tumbled as investors sold loans.
Investors’ need to deploy cash in a slower market with fewer deals is expected to overcome concerns about Power Solutions’ high leverage, aggressive documentation and structural challenges to the automotive industry as it transitions to electric vehicles.
“There are almost no other loans in the market right now,” a senior CLO portfolio manager said. “That is as good of a backdrop as you can get if you’re Johnson Controls.”
US leverage loan volume stands at US$116bn so far in 2019, which is 66% lower than the US$343bn total a year earlier due to lower refinancing activity after December’s pricing correction. There are no other deals of this size in the pipeline in the US or Europe.
Investors also expect the loan to sell well, as its higher B1 rating is attractive and price talk of 400bp is on market, despite concerns about the deal’s tough documentation and leverage.
“Johnson Controls’ (loan) will absolutely fly out of the door. It’s a decent deal and ticks all boxes other than documents. If you’ve got four boxes to tick and you have three, that’s good enough,” a second senior loan investor said.
Private equity firm Brookfield Business Partners and pension fund Caisse de depot et placement du Quebec announced the US$13.2bn buyout of Power Solutions in November 2018.
The buyout is backed with US$5.45bn of loans, which will be denominated in both dollars and euros, as well as a US$2bn secured notes tranche and US$2.7bn of unsecured notes, which will also be in dollars and euros.
The loans will be split between a US$3.2bn dollar-denominated loan and a US$2.25bn-equivalent euro-denominated loan. Pricing on both tranches is being guided at 400bp-425bp over the respective benchmarks.
Ratings agencies have issued a corporate rating of B1/B+/B+. Moody’s estimates free cash flow generation in the US$375m to US$400m range for the 12-15 month period following the transaction, which is expected to help reduce leverage and improve ratings.
Investors are currently favoring larger, better-rated businesses with strong fundamentals in a late cycle environment, after a spike in volatility at the end of 2018 and the beginning of 2019.
“The B1 rating makes a big difference,” the second senior loan investor said.
The reduced loan size is also expected to support demand. Banks originally underwrote a US$5.2bn dollar-denominated term loan, but the loan was cut to US$3.2bn after US$2bn of secured notes were added to take advantage of red-hot demand for high-yield bonds, a senior banker said.
Concerns about the battery maker’s exposure to the slowing automotive industry is offset by the company’s ability to provide batteries to used and new cars, which investors are seeing as recession proof.
“Even all of the new electric cars and hybrid cars need the traditional batteries that Johnson Controls makes,” a second senior banker said.
For investors, the company’s loan documentation, high leverage and a relatively low equity check from the company’s private equity owners are more pressing issues, but are unlikely to be dealbreakers.
Investors said that Power Solutions’ loan document includes the full range of aggressive features, including a weak Most Favored Nation (MFN) clause and the ability to take large carveouts to finance dividend payments and add significant amounts of extra debt going forward.
“You name it they can do it – literally everything,” the second loan investor said.
Investors described Power Solutions’ documentation as more aggressive than jumbo loans for Refinitiv and Akzo Nobel, which were syndicated last September and erred on the side of caution due to their large size and synchronicity in market.
“It (Power Solutions) is probably worse than Refinitiv and Akzo. The market was nervous when they came but reset after they did well. This feels more bullish from the start,” the second loan investor said.
The company will have adjusted leverage of 6.1 times following the buyout, according to information provided to investors. US financial regulators expressed concerns over leverage levels above 6.0 times in US leveraged lending guidelines, which were implemented in 2013 to limit systemic risk.
“Pricing seems fair and we like the business,” the third investor said. “It is just a touch too levered.”
Brookfield Partners is also backing the deal with more debt and a smaller equity check of 23% than most deals. In the fourth quarter of 2018, the average equity check was 40%, according to LPC data.
Retail loan outflows slowed to US$33m last week, which was the smallest amount seen after 15 weeks of outflows totaling more than US$15bn, whereas high-yield has seen strong inflows. In the week ending January 17, investors added US$3.3bn into high-yield funds, the most since late 2016.
Demand from Collateralized Loan Obligations (CLO) funds, the biggest loan buyers, has also picked up after a slow start with approximately US$18bn issued so far this year, according to LPC, a division of Refinitiv.
“CLO managers are not sitting on a ton of cash. If they don’t want to play Johnson Controls they don’t have to, but they probably will because supply is so low,” the CLO portfolio manager said.
(Additional reporting by Tessa Walsh.)
Reporting by Jonathan Schwarzberg and Prudence Ho; Editing by Michelle Sierra and Jon Methven