Leveraged lending pulls US syndicated loan volume down 6% in 2015
NEW YORK: Market volatility spurred by swooning oil prices, as well as regulatory constraints and uncertainty over the timing of Federal Reserve rate hikes, tugged US syndicated lending down by 6% last year to $2 trillion. Leveraged lending led the downturn, sinking by 17% and offsetting the 4% rise to a record volume of investment-grade loans backing a spate of mega-mergers, according to Thomson Reuters LPC data.
A conservative approach by lenders and investors biased toward higher-quality loans will extend at least into the early months of the New Year, investors and analysts said.
Adherence to regulatory guidelines, designed to thwart systemic risks by curbing the amount of debt taken in leveraged buyouts (LBOs), has taken hold, keeping total leverage relatively low. In recent months, investors have expressed worries about market turmoil by selling high-yield debt. Fund managers needing to raise money to fulfill redemptions have been unloading their more liquid assets, including better quality loans.
It was a tale of two loan markets last year, where credit quality was paramount to access funding, another trend that will persist. “If a deal has what people view as good credit quality, where there are no concerns about the quality of the business, we see those deals getting done,” said John Sherman, a managing director at DDJ Capital Management. “Those companies that have secular risks or other business risks that investors identify, people are just avoiding those at all costs.”
Investment-grade syndicated lending climbed 4% to an all-time high US$873bn, propelled by record merger and acquisition financing, while leveraged lending sank 17% to US$783bn.
LBO loan issuance slid by 22% in 2015 to US$73.4bn.
“We believe the trend will be toward higher quality credits,” said Richard Kurth, co-head of leveraged credit at GLG Silvermine. “Our read on the new issuance calendar in Q1 is plus or minus US$60bn of leveraged loans for M&A, which is fairly robust,” he said. “There’s plenty of capital around, which is the underlying theme.”
Now that the Federal Reserve raised interest rates in December for the first time in almost a decade, investors in loans, pegged to floating rates, are eager for clues about the pace of future rate hikes.
Retail investors in bank loan funds and exchange traded funds (ETFs) ran for the exits through most of last year, in the absence of Fed hikes. These investors withdrew more than US$20bn after yanking out almost US$24bn in 2014, according to Lipper.
Still, leveraged loans outperformed high-yield bonds. Average total returns fell 0.88% for loans last year, while falling 3.9% for high-yield bonds, said Jeff Tjornehoj, head of Americas Research at Lipper. High-yield bonds are more exposed than loans to troubled energy companies. US oil prices have fallen by about three-quarters since the summer of 2013, eating into the profitability of oil and gas companies. Investors are also broadly worried that rising rates will boost corporate defaults.
“If rotating out of high yield, we think consideration should be given to leveraged loans, especially with the rate movement we’re likely to get from the Fed,” said Kurth. “For a new investor coming into leveraged loans it’s potentially a nice entry point.”
Renewed retail buying as the Fed keeps raising rates would help offset the slump in Collateralized Loan Obligation (CLO) fund creation spurred by risk retention rules that become effective at year end.
Issuance of CLO funds leading up to the rules, which force the biggest buyers of leveraged loans to hold a stake of their deals, shrank by 20% last year to US$98.4bn. In addition to monitoring the pace of rate hikes, investors seek some stability in commodities and broader markets before committing to higher-risk deals. Year-end volatility hung up a handful of leverage loans still awaiting syndication.
Separately, there are at least half a dozen new-build US construction power project financings in the GE Energy Financial Services pipeline for various clients coming to market this year, said Don Kyle, senior managing director at GE Energy Financial Services, the energy investment unit of GE. Financing volumes might rise slightly, between equity and debt investments, from each of the two prior years. Most of these multi-year projects are being financed by banks using delayed draw construction loans, where pricing has been “pretty stable,” Kyle said.
The broader M&A leveraged loan space, however, has been extremely sensitive to commodities among other risks. “This segment is looking for a number of things to stabilize: oil and gas prices – it wouldn’t hurt to have a cold spell – the wind-down in CLO creation and outflows from funds. Improved technicals are needed.”