LPC: Demand for yield fires up US second-lien market
NEW YORK, April 13 US investors are turning to higher-yielding second-lien loans as primary spreads on US leveraged loans continue to fall in an aggressive repricing round and new deals remain scarce.
Second-lien volume of US$8.61bn in the first quarter was more than five times higher than US$1.54bn booked a year ago when bank appetite waned amid market turbulence in late 2015.
“The market is incredibly hot right now. In a thin market people tend to take on risk. Where do they go? To the credits they know, but further down the risk spectrum,” one investor said.
Second-lien debt is considered more risky as it sits behind senior first-lien bank debt in corporate capital structures and offers higher returns to investors.
Although second-lien loans can be a difficult sell in choppy markets, loan market conditions are robust and banks and loan buyers currently have a ‘risk on’ mindset, market participants said.
Yields on first-lien institutional term loan yields have sunk to levels not seen since 2004, Thomson Reuters LPC data shows. Average yields on first-lien term loans were 4.5% in the first quarter, down from 6.54% a year earlier.
Average yields on second-lien term loans were 9.85% in the first quarter, compared to 10.78% in the first quarter of 2016, according to Thomson Reuters LPC data.
This price compression has been driven by unrelenting demand for yield and floating rate loans since last year as investors try to hedge against rising interest rates, allowing issuers to cut borrowing costs with opportunistic refinancing.
Junk-rated companies refinanced a total of US$261bn in loans in the first three months of the year, leaving the prior 2Q13 record of US$246bn behind.
Retail investors have poured US$12.9bn into bank loan mutual funds and exchange-traded funds as of April 5, lifting total inflows since early August 2016 to about US$23.6bn. New collateralized loan obligation (CLO) issuance, a measure of institutional demand, was roughly US$16bn in the first quarter.
In another measure of risk appetite, riskier triple-C rated loans have rallied more than double-B names in the secondary market since the end of last year.
In early December, the average secondary price for CCCs rose 2.81 points to 87.8 from 84.99 on December 1. The average secondary price of BB-rated loans increased 31bp to 100.09 from 99.78 in the same time.
BUYER BASE
Increased appetite for risk assets is creating a broader buying base for second-lien loans, which includes insurance companies, pension funds, and alternative asset managers as well as alternative lenders.
Alternative lenders stepped in to provide privately-placed second-lien loans when banks stepped away from underwriting loans for syndication in 2015, which were sold to business development companies (BDCs) and other direct lenders.
Direct lenders are seeing fewer lending opportunities in a hot market as banks return to lending and are now targeting second-lien debt. Direct lenders are still needed at the larger end of the middle market for issuers in the US$75m-US$100m Ebitda range, which do not require a broad syndication effort but are large enough to require a handful of direct lenders of scale to place the junior debt.
“There are situations where a pre-placed second-lien loan makes more sense and is useful to sponsors in terms of execution and certainty,” a middle market credit investor said.
High precision manufacturing services company Tecomet Inc is in market with a US$835m acquisition loan including a US$225m second-lien tranche that financial sponsor Charlesbank opted to pre-place with a trio of investors, including at least two direct lenders, sources said.
Three of the largest second-lien loans marketed in the first quarter came via the syndicated loan market, however, and financed dividend recapitalizations along with first-lien loans.
Barclays arranged a US$690m second-lien term loan for real estate investment trust Capital Automotive and warehouse retailer BJ's Wholesale Club's sealed a US$625m second-lien term loan led by Nomura which was upsized by US$25m during syndication.
Life sciences company Avantor Performance Materials also upsized the second-lien portion of a dividend deal. The company raised a US$455m second-lien term loan, which was increased from US$380m at launch and was led by Jefferies. (Reporting by Leela Parker Deo; Editing By Tessa Walsh and Jon Methven)