The leveraged loan market continues to be the destination of choice for many corporations. Callability and historically low spreads have been enticing enough over the past year for sponsors to finance their purchases largely in loans. But some bankers say that loan investors are beginning to rationalise their market (for second-lien paper especially) vis-à-vis the high-yield bond market.
As a result, loans are becoming less flexible and more expensive financing vehicles. And high-yield investors could be the beneficiaries, as more financing that months ago would have been exclusively earmarked for the loan market heads their way.
Specifically, an increasing number of cases indicate that issuers have flexed up pricing or added non-call provisions to second-lien loans, making the loan market sometimes less attractive than it was. When adjusted for floating rates and callability, high-yield bonds are beginning to look more attractive to issuers, according to some bankers.
“If second-lien loans are adjusted from floating to fixed, and callable immediately to a non-call piece of paper like a bond deal, then yields are higher on second-liens than bonds,” said one capital markets head. “This has been seen in the last month or two and is due to more rational investor sentiment.”
Issuers are taking notice. Selecting the second-lien loan over the high-yield bond is not the obvious choice it once was, some say. No one is suggesting a mass exodus from the second-lien loan market; indeed, volumes there continue to grow. But what is suggested is that more issuers will begin to supplement their financing with larger bond tranches, which have often been trimmed in the past year when over-liquid loan investors proved more than willing to take increasingly larger tickets.
Recent deals for Sabre Holdings and Building Materials Corp of America reveal how the debt market, in some cases, has been trending away from bonds. Last month, Sabre cancelled plans to conduct a US$700m note offering, instead making use of the loan market to launch a US$3.515 loan through Deutsche Bank and Merrill Lynch.
At the same time, BMCA failed to attract enough demand for its US$325m bond. Instead, the company found a safe haven in the second-lien loan market, completing an equally sized loan offering that was twice covered.
Nonetheless, for certain companies, one market will always be favoured over the other. Take Huish Detergents, which is in the market with a buyout financing through JPMorgan. That loans are typically callable at par at any time is an ideal feature for this company, which has strong, stable cashflows as a key player in the private-label laundry detergent market.
With the knowledge that loan investors had changed their outlook, Huish and Vestar Capital Partners, its sponsor, inserted non-call protection for the first year (then 102, 101) in the second-lien loan knowing that its business now has plans to repay the debt in the first year.
A banker said that the non-call provision would enable the Caa1/CCC+ rated US$275m second-lien tranche to achieve pricing of Libor plus 450bp. Huish’s pro forma leverage is 7x and it had to give loan investors call protection – a typical bond feature – to knock down pricing to a suitable level.
On the other hand, bankers indicate that if a company has a more traditional amount of free cashflow, or if there isn’t an obvious immediate exit, a bond deal could be more likely. And while last week proved quiet in the new issue bond market, there is plenty of event-driven supply in the offing, bankers assert.
A slew of corporate-to-corporate deals and leveraged buyouts are set to be announced in the coming months, which will bring bonds deals sized in the US$5bn–$10bn area.
“This is the most noticeable trend,” the first banker added. “A US$1bn bond deal used to be big, but we’ve got US$5bn, US$6bn offerings coming up that are starting to look like everyday deals. We’re less focused on the US$1bn deal.”
Already the market is expecting large deals from TXU, Tribune, Harrah’s Entertainment and Clear Channel Communications later this year. The US$45bn buyout of TXU by KKR, Texas Pacific Group, Goldman Sachs, Lehman Brothers, Citigroup and Morgan Stanley is slated to be the largest buyout in history and is expected to be financed with roughly US$7bn in high-yield bonds.
Tribune expects to tap the leveraged markets for US$7bn, including a large bond, to fund its going-private transaction. Harrah’s Entertainment has a US$6.025bn bond deal planned to fund its acquisition by Apollo and Texas Pacific Group.
Helping borrowers along will be the tightening spread environment. High-yield spreads remained historically tight at 275bp over Treasuries last week, according to the Merrill Lynch Master II index. During the broader market blip in early March, they had widened to 299bp. The market has remained in its continued tightening phase since October 2002, when average spreads approached 1,000bp.
In the year to-date, global high-yield issuance has reached US$48.8bn from 102 new deals, according to Thomson Financial. This still pales in comparison with the global leveraged loan market, which saw US$413.6bn in borrowings from 603 issues. The amount of global second lien loan issuance from 80 issues stands at US$11.5bn in the year to-date.