NEW YORK, March 6 (LPC) - Banks, fresh off of a record year of providing pro rata loans to highly indebted corporate borrowers, are finding steady demand this year from issuers seeking to lock in lower interest rates as non-bank pockets have thinned and their funding becomes more expensive.
A pricing gap opened up during the volatile fourth quarter in leveraged loans, making it more cost effective for borrowers to lean toward bank-issued term loan A debt over term loan B debt from groups of investors including non-banks.
“There’s been a widening in spread between the structures. The term loan B market has generally widened out 50bp to 62.5bp, repricing for the same level of risk from a year ago,” said Art de Pena, head of loan syndicate and distribution at MUFG Securities. “Banks haven’t done that – banks are still holding tight on pro rata pricing for higher-quality leveraged deals – pricing has widened 12.5bp at best.”
That disparity sweetens the incentive to lock in term loan A debt, especially for issuers rated BB and above.
Computer company Dell Technologies, for instance, is in the market via JP Morgan with a US$4.116bn term loan A that will be used to refinance its existing term loan A of the same size. Loan pricing for the company, rated Ba1/BB+/BB+, is circulating at 175bp over Libor with a 0% floor and is expected to price this week, a banking source said.
The typical BB-rated pro rata loan paid 220bp over Libor while a term loan B paid 265bp over Libor as of February 27, according to LPC, a division of Refinitiv.
Lower borrowing costs are also a function of issuer concessions on documentation. Term loan As, in addition to a comparably strict amortization schedule, usually have financial covenants that protect investors whereas most term loan Bs are issued with few or no covenants.
The decision to renew its term loan A was a capital structure decision by Dell, which had US$45.5bn of debt on its books as of February 1, according to a leveraged finance banker. Issuers with large amounts of debt typically use a variety of debt instruments that offer different prices and conditions to spread out the risk.
JP Morgan and Dell declined to comment.
The bank market has gained luster as investors’ money in institutional leveraged loans has left the system since December, when it became obvious that US interest rates would not continue climbing at the same rate they had since December 2015. Leveraged loans, which have yields that rise with rate hikes, lost some of their floating-rate appeal, driving better-rated borrowers to seek alternative markets for funding.
Retail loan funds have had investors withdraw money for 15 consecutive weeks, to the tune of more than US$15bn, according to Lipper. However, this past week saw investors pull just US$33.1m.
Concurrently, more than US$18bn of US Collateralized Loan Obligations (CLOs), the biggest buyers of loans, was arranged in the first two months of the year.
Despite the fact that the money exodus has slowed and the term loan B market is open for business, concerns prevail that the institutional market may not be able to absorb the mammoth-sized loans it gobbled up last fall.
“Although there are signs that the market has stabilized, the term loan B market experienced significant volatility toward the end of 2018,” said Jason Kyrwood, a partner at law firm Davis Polk & Wardwell. “Borrowers with more challenging credit stories were not able to command the same flexibility and rate that they were even a few months before that. This had some looking for alternative sources of capital and one such source is the term loan A, or commercial bank market.”
Leveraged pro rata term loan volume of US$35.2bn year to date is down from US$50.8bn in the same period last year, according to LPC data. This quarter’s pace comes on the heels of record leveraged pro rata volume of US$514.1bn last year, which beat the prior all-time high of US$509.8bn set in 2013.
Still, demand from the pro rata market lenders for leveraged issuers is stronger than it was last year, the leveraged finance banker said.
“Term loan As make more sense than term loan Bs when there is market volatility, because term loan As are repaid at a higher rate per year,” said Ellen Snare, a partner at law firm King & Spalding. “As a result, they reduce risk more meaningfully over the term of the loan by shrinking the principal balance owed more quickly.”
As concerns about a potential recession mount, borrowers are also facing more pressure from lenders to show they are quick at repaying their debt, also arguing for term loan As, which amortize more quickly than term loan Bs.
Packaging company Greif Inc on February 11 inked a US$1.675bn term loan A to back its acquisition of paperboard manufacturer Caraustar Industries. The deal includes a US$1.275bn five-year loan (175bp over Libor) and a US$400m seven-year loan (200bp over Libor). The amortization schedule for the BB-rated tranche included in the deal will help the company cut leverage to its target area of 2-2.5 times within three to four years from 3.5 times immediately following the deal, according to a company statement.
Greif did not return a request for additional comment.
“Deleveraging is very important right now,” said a loan investor. “Lenders want to see that you are actually going to follow up on what you say you are going to do.” (Reporting by Lynn Adler and Jonathan Schwarzberg; Editing by Michelle Sierra and Jon Methven)