Tuesday, 20 Oct 2020

U.S. loan issuance plummets in second quarter as market takes stock of new normal

NEW YORK (LPC) – Issuance across the U.S. syndicated loan market plummeted in the second quarter as the asset class navigated a slow recovery from the novel coronavirus that left borrowers scrambling for cash to keep their businesses alive while economies around the world gradually reopen.

Companies from beleaguered sectors, including United Airlines and cruise ship operator Carnival Cruise Line, collectively raised billions of U.S. dollars in new, costly loans to bolster liquidity amid a pandemic that forced many consumers to shelter at home throughout the second quarter.

Investors, concerned about defaults and downgrades, flocked to quality, preferring deals for companies with higher credit ratings and strong collateral packages. The wary buyside limited its exposure to low, Single B rated loans that are subject to fall to Triple C, which is just notches above a default.

Default volume for US leveraged loans through mid-June totaled US$36.9bn, including US$14.6bn in May, which was the most defaults in a month since April 2014, according to a June 19 report from Fitch Ratings.

“The loan market is healing and getting back to more normal terms,” said Michael Marzouk, managing director for bank loan strategies at Pacific Asset Management. “Loan volumes are lower, but the secondary market has tightened and there is much more fluidity in the asset class.”

The LPC 100, a cohort of the 100 most liquid US leveraged loans, recovered to 93.07 cents on the dollar on Tuesday, from a nadir of 77.87 cents on March 23.

REACHING HIGHER

Leveraged loan issuance tallied roughly US$113.8bn for the second quarter, a sharp drop from the US$271.5bn raised in the first quarter of this year, according to data from Refinitiv LPC.

Of the US$113.8bn of volume, only US$11.4bn of the loans carried a rating of Single B, underscoring investor reluctance to commit to borrowers exposed to potential downgrades to Triple C. In the first quarter, US$94.7bn of loan issuance was rated Single B, according to the data.

Collateralized Loan Obligations (CLOs), the single-largest buyer of new leveraged loans, can only hold a certain portion of facilities rated Triple C before triggering tests within the fund. Investing in higher-rated loans allows CLOs to improve the average rating within their portfolios.

“Some of these downgrades happened amid market uncertainty,” said Lauren Basmadjian, a senior portfolio manager at the Carlyle Group. “And Covid-19 was the straw that broke the camel’s back for companies that had already been struggling pre-Covid.”

UNCERTAIN FUTURE

Investment-grade and leveraged merger and acquisition loans fell to US$52.4bn in the second quarter from US$79.3bn in the first, according to Refinitiv LPC data.

The dip in M&A comes as market players struggle to evaluate risk in a global economy still grappling with the consequences of the economic slowdown brought on by Covid-19.

However, intervention from the US Federal Reserve to partake in bond-buying has buoyed credit markets. Bankers leveraged that momentum in the second quarter to syndicate bonds and loans for M&A deals that were underwritten before the pandemic halted new issuance, leaving banks stuck holding onto the debt.

In June, technology services provider Tech Data raised roughly US$2bn in loans to fund its buyout by private equity firm Apollo Global Management. Casino operator Caesars raised US$1.8bn in loans that backed its acquisition by peer Eldorado Resorts and German elevator manufacturer ThyssenKrupp on Tuesday finalized roughly US$4bn in loans to back its buyout by a consortium of investors led by Advent International and Cinven.

COSTLY EXERCISE

In order to offload these loans, underwriters sold the debt with steeper original issue discounts and juicier coupons. In fact, the average three-year yield on first-lien loans widened to 7.55% in the second quarter from 5.04% in the first three months of the year. And throughout June, the average discount for new, first-lien leveraged loans was roughly 97.1 cents, compared to 99.7 cents for new leveraged loans issued in February, Refinitiv LPC data showed.

In particular, a US$537m loan supporting energy business Apergy’s tie-up with Ecolab’s upstream business cleared at a discount of 94.5 cents on the dollar in early June. Just days later, entertainment technology firm Xperi’s US$1.05bn loan supporting its merger with TiVo was offloaded at a discount of 90.5 cents as skeptical investors pushed back on new money transactions amid heightened economic uncertainty.

“We’re hopeful of moving beyond the crisis, but each day the headlines change and prognostications about a recovery or a second lockdown create uncertainty for the marketplace,” said a senior banker.

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