What a difference a year has made. The leveraged loan market appears to have turned a corner, and a big part of that has been the willingness of banks to turn on the faucet and fund new deals. This was especially true during the third quarter. And while no one expects that faucet to morph into a fire hose anytime soon, many market participants believe lending will continue to increase for the remainder of 2009 and into 2010.
“Firm underwritings have been scarce, but we just provided our first four fully underwritten commitments for the first time basically since the beginning of the year,” said a New York-based banker. “And we’ve gotten half a dozen underwrites approved on top of that. So we’re back in business.”
Volume in the third quarter totaled $53.5 billion, according to Thomson Reuters. That brought the total year-to-date volume to $161.5 billion.
At a recent press briefing, Larry Kantor, head of research at Barclays Capital, pointed out that there is still a lot of economic stimulus money that has yet to make its way down to bank lenders. “Credit conditions for businesses are better than three months ago,” he said. “And they will be better three months from now,” mainly because of the stimulus money that has yet to reach the banks.
But banks are just part of the picture. Investors have stepped off the proverbial sidelines to play ball. Not a tough decision to make, with market indicators like the Standard & Poor’s/Loan Syndications and Trading Association’s Leveraged Loan 100 index hitting an all time high on Sept. 25, returning 46.97% year to date. The loan market has even seen a few issues trade up, some past par, after breaking on the secondary. This was something that seemed like it would never happen again a year ago.
And this hasn’t been the case for higher-rated companies alone. Just this week, a $250 million term loan for single-B-rated Delta Air Lines, which priced with an OID of 98, shot up more than two cents after breaking on the secondary, to trade around 100.5.
“Judging from the demand from recent airline and M&A deals, it would appear that there is a real hunger for this paper, leveraged or otherwise,” said another New York-based banker. “With all the repayments and the technical recovery in the secondary market, there should be plenty of money on the sidelines that needs to be put to work.”
And some market participants believe the banks will begin to fund more companies that continue to struggle. This means investors could see more issues in sectors such as home building, retail, gaming and automotive.
Furthermore, investors expect deals to continue to look more or less the same—as one source put it, “vintage ’09 deals,” that is low leverage, a decent spread, no equity cures and no covenant-lite deals.
“The banks are very busy pitching deals as we speak,” an investor with a large money management firm said. “M&A appears to be thawing, and this will only contribute to this financing activity. Spreads will continue to tighten, with affordability of leverage improving dramatically. And M&A will resume as a result. Look at Xerox and Affiliated Computer Services. We will also see more and more pure refinancing to push out maturities. Vulcan Energy was an example of that.”
But not everyone is convinced that lending will pick up over the next few months. “I think the fourth quarter will be slow unless issuers really drive the bus,” said a New York-based investor. “I would expect there to be a lack of risk taking by the banks as the last thing they want to do is jeopardize their year.”
A California-based investor said that he wanted to believe the market could get better, but “I think the [banks] are hiding tons of crap that needs to be written down.”
A Boston-based investor echoed that sentiment. “I think there will be some more scary numbers from banks, many of them having been held back by favorable accounting. The banks will slowly release these numbers, which will offer a brief scare, but nothing fundamental or systemic. Only a few banks will have concentrations that are life threatening. They will slowly turn the switches back on. And you will see year-over-year increases, but from a very low base in Q4 and Q1. Things won’t really get going until late Q1 2010, which isn’t that far away.”
Some market participants are also concerned that corporate credit will take a hit if and when the Federal Reserve starts raising interest rates. However, this, sources said, should be a distant worry because the Fed hasn’t signaled that it will raise rates anytime soon. Besides, corporate credit has done well in the early stages of a Fed tightening cycle, mainly because the market dovetails with better economic conditions and declining default rate expectations, sources said.
“Fear is rampant, but reality will break through,” the Boston-based investor said. “Reality moves up and down with low single-digit percentage points, usually up slowly, while perceptions are a bit more manic.”