April 17, 2019 / 8:34 PM / a month ago

US leveraged loans calendar shows green shoots

NEW YORK, April 17 (LPC) - The calendar for US leveraged loans is at the highest point of the year with new deals including drug developer Catalent Pharma Solutions’ US$1.2bn purchase of gene-therapy company Paragon Bioservices and private equity firm Apollo Global’s US$1.1bn acquisition of Smart & Final Stores providing a boost.

The pipeline still stands well below its April 2018 and April 2017 levels, after concerns over global growth and the possibility that steady interest rates would not continue to support demand for the floating-rate asset class caused lending activity to grind to a halt at the end of 2018.

Banks pulled back on underwriting new transactions as secondary loan prices dropped to levels not seen in years, hindering the refinancing flurry that boosted early 2018 volumes.

“Supply is so low because no one underwrote deals during November and December,” said a portfolio manager. “You are seeing banks underwriting again, but true M&A takes a long time to get going again once it slows down.”

SLOW ROLL

As a result, loan buyers expect most of the business starting off the second quarter will remain under the billion dollar mark with an emphasis on add-on deals for dividends, general corporate purposes and tack-on acquisitions.

As the market continues to heal, such deals should be followed by even larger merger and acquisition-related transactions. LPC’s index of the most heavily traded loans broke above 98 for the first time since mid-November on April 15. The index sank to a multi-year low of 94.57 on December 28.

“Every day it feels like it’s trending higher,” the portfolio manager said.

The pipeline is currently US$38.2bn, including transactions in market and deals that are scheduled to come to market, according to data from LPC, a Refinitiv company. This is down 17.1% from 2018 when the level was US$46.1bn at this time of year and 32.5% lower than US$56.6bn in 2017.

BRING ON THE M&A

Loans financing M&A make up roughly 42% of the calendar, according to LPC, which highlights the lack of refinancing transactions. During the first quarter of 2018, M&A made up just 24.6% of volume.

M&A is playing a large part of overall activity. However, since loan issuance is down this year, M&A volume was just US$58.2bn during the first quarter, down 31% from the same quarter in 2018.

The number one reason given for the lack of M&A-related loans is that acquisition multiples are too high. The volatility at the end of 2018 gave some hope that companies would start raking up targets, but the market snapped back during the first quarter, and multiples are back to where they were in 2018 prior to the volatility.

Sponsors have been active behind the scenes though the deals are not huge in scope and there is not a buying frenzy despite the fact that private equity firms have a record amount of dry powder on hand, three bankers agreed.

“I’d classify the amount of early M&A processes as okay,” said a head of leveraged finance at an investment bank. “We are probably looking at 10-15 new deals a week, which isn’t incredibly busy but it shows that activity is going on. I think things will be picking up.”

A second banker said the decision by the Federal Reserve to postpone rate increases has helped give at least a small boost of confidence to private equity firms looking to predict borrowing costs when calculating potential returns.

“We’re getting back to what I consider normal,” said the banker, who specializes in M&A. “It’s helpful to know you’re in a window of a little more stability. I think it gives a little more comfort on execution.”

Both bankers and investors alike said they expect private equity to provide the fuel for additional M&A activity when it picks up.

Preqin, a data provider, noted in January that private capital now has more than US$2trn, for the first time, waiting to be deployed with US$1.2trn of this coming from private equity funds.

A collateralized loan obligation (CLO) investor said this amount of money guarantees that private equity firms will start buying again, even if multiples seem high and there are questions over interest rates.

“I have full faith that we’ll see a pick-up,” the investor said. “It’s just a question of when.” (Reporting by Jonathan Schwarzberg. Editing by Michelle Sierra and Lynn Adler)

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