Despite some correction in the credit markets in favor of investors and lenders in the second quarter of 2013—particularly in June following the Federal Reserve’s announcement that it will begin to taper its bond-buying program later in the year if economic growth meets expectations—the first half of 2013 continued to be a strong leveraged loan market for issuers. There continues to be an oversupply of capital for available transactions in many asset classes. Leveraged loan volume totaled approximately $350 billion over the first half of 2013, an approximate 75 percent increase over the same period for 2012. Middle-market loan volume also increased for the same period year-over-year by approximately 44.5 percent, from approximately $4.5 billion to approximately $6.5 billion. Most leveraged loan activity continued to be dictated by refinancings, primarily repricing amendments and extensions, and continued strong activity for leveraged dividend recaps for most months during the period (other than June, which saw at least 16 dividend recap transactions pulled from the market) as mergers and acquisitions activity remained soft. Similarly, the high-yield bond market was severely disrupted by the Federal Reserve’s announcement causing outflows of available capital for high-yield investments into other asset classes, resulting in an overall decrease of approximately 9.5 percent in new issuances of high-yield bonds in the second quarter to approximately $81 billion.
The first half of 2013 saw attractive pricing for issuers as a result of the continued strong demand by investors looking to deploy capital. Pricing spreads for single B-rated issuers increased from approximately L+372 to L+416 as compared to BB-rated issuers, which saw spreads increase from approximately L+265 to L+308 during this period. In June 2013, refinancings driven by pricing concessions were limited as lenders were less receptive to giving the requested concessions. In comparison, middle-market spreads for the last 90 days on first lien debt has run approximately L+562. The ultimate impact of the June correction on the middle market, which tends to react more slowly than the broadly syndicated market, has yet to be determined.
Covenant-lite loans as a percentage of financings in the institutional market have shown a downward trend from the first quarter to the second quarter of 2013. Covenant-lite loans are loans that may have one or more of the following features:
- No maintenance covenants (such as financial covenants) or maintenance covenants that only apply to, or are for the benefit of, the revolving lenders in the loan facility (which may be “springing covenants” when certain outstanding borrowing levels are reached); or, if the maintenance covenant is not completely eliminated, establishing covenant cushions from the issuer’s projections that are more generous than the typical 20 percent to 25 percent cushion
- An incurrence test (e.g., compliance with a leverage test or interest coverage test at the time of the incurrence of debt, but no requirement to maintain compliance after it is incurred)
Institutional deals that contained covenant-lite structures represented approximately 44 percent of financings in the second quarter of 2013, down from approximately 57 percent in the first quarter of 2013, with June slipping to approximately 27 percent. However, this volume far exceeded the number of covenant-lite deals in 2012, increasing from approximately 52 loan transactions to approximately 200, an increase of approximately 285 percent.
Sponsors continued to drive leveraged dividend recap loan volume during the first half of 2013. Sponsor-backed issuers represented approximately 77 percent of dividend recap loan financings, approximately $35 billion. Total dividend recap volume for the first half of 2013 totaled approximately $46 billion as compared to $32.2 billion for the second half of 2012. This is contrary to predictions by some market observers that the volume may trend downward in 2013 as a result of what many believed was an acceleration of dividend recap financings into the latter half of 2012 because of uncertainty regarding U.S. tax policy, fiscal cliff concerns, etc. Notwithstanding the June 2013 correction and the downward impact it had on dividend recaps, second quarter dividend recap volume increased overall from approximately $17.8 billion in the first quarter of 2013 to approximately $27.8 billion, a 56.2 percent increase.
Issuers looking to finance in the asset-based lending market will find that pricing remains competitive. Volume is up slightly in the second quarter of 2013 (approximately $2.6 billion) over the same period in 2012 (approximately $2.5 billion), but down approximately 60 percent when compared to volume in the first quarter of 2013 of approximately $6.5 billion. Retail food and drug (approximately 28 percent), food and beverage (approximately 16.7 percent), services and leasing (approximately 10 percent), building materials (approximately 9.5 percent) and forest products (approximately 7 percent) were the five most active sectors for asset-based lending facilities in the first half of 2013.
Collateralized loan obligation (CLO) issuances continued to decline in the second quarter of 2013 to approximately $16 billion from $26.3 billion in the first quarter, a decline of approximately 40 percent. Lack of collateral supply and acceleration of transactions into March 2013 in front of the new Federal Deposit Insurance Corporation (FDIC) rules that were to take effect in April requiring banks to apply higher capital requirements to AAA CLO paper were the main drivers of this decline. The new FDIC rules (resulting in less demand by banks for senior liabilities) caused AAA CLO liabilities spreads to widen to L+110–115 by the end of June from L+130 for earlier periods in the year. Likewise, CLOs’ share of the overall primary market was reduced to approximately 53 percent, down from approximately 60 percent in March.
It remains to be seen if the June correction will have long-term effects on the second half of 2013. In the short run, continued oversupply of capital should make for an accessible leveraged loan market for issuers. Pricing and structure of financings may continue to move in favor of investors, but should still provide issuers the flexibility desired to complete financing transactions. As private equity firms’ expectations related to dividend recap financing pricing and structures settle, we should continue to see the use of this financing vehicle by private equity firms to harvest value from portfolio companies.
Sources: Standard & Poor’s Leveraged Commentary & Data and KPMG Corporate Finance