NEW YORK, Feb 17 (Reuters) - Institutional leveraged loan buyers are looking to higher priced middle market loans as an offset to the repricing blitz pushing yields in the large corporate market to lows not seen since 2004.
This quarter, the average yield on a large corporate institutional term loan is 4.46%, compared to 5.88% for middle market term loans, Thomson Reuters LPC data show.
The roughly 142bp middle market yield premium is attracting demand from institutional investors, such as Collateralized Loan Obligations (CLOs), as they search for opportunities to generate additional yield.
“To the extent they can, they will,” said one middle market lender of the CLO bid for middle market loans. “If it’s a rated execution, it will get some sort of CLO participation.”
In another measure of institutional demand, middle market loans are being bid up in the secondary market, suggesting loan buyers are looking for value there.
The middle market cohort, which includes loans with overall deal size between US$100m-$300m, increased to the 96.9 context from 95.81 at the beginning of the year, putting it just two points below the SMi100, which tracks the 100 most widely held US loans.
Middle market loans are typically less liquid and bank groups comprise a handful of lenders, appealing more to a buy-and-hold investor base in contrast to the broadly syndicated loan market where loans change hands easily and often.
This makes the middle market more immune to the type of wholesale repricing wave currently sweeping the leveraged loan market.
Characteristically, the middle market segment has held fairly steady in terms of the number and pace of issuers seeking to cut borrowing costs or refinance existing debt at more favorable terms.
Beyond repricings, middle market lenders in general are holding the line on pricing compared to the broadly syndicated market where more often than not spreads are slashed even further during syndication.
The middle market recorded only four downward flexes in the first half of the first quarter, while in the same period there were 54 in the large corporate market, 38 of them in January.
Nevertheless, the surplus of demand is spilling over into the middle market, putting downward pressure on spreads and creating opportunities for mid-sized borrowers to nab issuer-friendly terms.
Industrial manufacturer SeaStar Solutions is repricing its US$272m term loan to a range of 350bp-375bp with a 1% Libor floor, down from 425bp. The company had previously tried to reprice its term loan to the same range in August 2014 but shelved the proposed transaction due to market conditions.
Demand is not only affecting spreads on existing debt, but also forcing down pricing on new deals. Middle market spreads are now in the 450bp-475bp over Libor range, said one lender.
“For any new transaction, I’m seeing more spreads in the 400s than in the 500s,” he said.
Middle market covenant-lite loan issuance is also notably high at US$1.45bn through February 8. Already 52.7% of middle market institutional issuance is cov-lite, compared to just 15.6% in 4Q16 and 8.6% for the whole of 1Q16.
The less restrictive covenant-lite structure favors the borrower and is hard to come by from traditional middle market lenders, especially for borrowers with less than US$50m in Ebitda.
The strength of institutional demand and the borrower-friendly environment is contributing to the increase in middle market covenant-lite volume, sources said.
Earlier this month enterprise software company Mediware sealed a US$320m covenant-lite term loan that backs its leveraged buyout by private equity firm TPG Capital. The final spread was 375bp over Libor, narrowed from guidance of 400bp-425bp. (Reporting by Leela Parker Deo; Editing By Michelle Sierra and Chris Mangham)