Amid the recent volatility and dramatic widening of spreads in the loan market, bankers are asking financial sponsors for the right to incorporate index-based flex language into debt commitment letters, several sources familiar with the discussions told sister service Thomson Reuters LPC. If incorporated, the language would provide capital markets bankers the ability to increase the overall yield on a loan during syndication if an index tracking leveraged loans, such as S&P/LSTA US Leveraged Loan 100 Index, trades below a certain level.
“It’s favorable to banks because there is a tangible trigger,” said one capital markets banker. “Once that’s tripped, we can kick in an additional flex on top of the initial.” Typically increased yields are achieved by a combination of a higher interest rate and a deeper original issue discount from par offered to lenders.
The call for an index-based trigger became louder following the dramatic, 5-point decline in secondary prices in August that caused many new loans to price far wider than initial talk, leading banks to lose out on the fees they typically charge. The fight for index-based flex language is an evolution of earlier discussions in July when bankers sought additional flex language ahead of the global pullback in all asset classes.
Since then, the struggles of bellwether issuers such as Blackboard, taken private this month by
Blackboard initially launched its $780 million first-lien buyout loan at LIB+550 with a 96.5-97 OID and a 1.5 percent Libor floor. But as the average price in the secondary loan market dropped from 97 to 92, Blackboard boosted price talk on its first-lien loan by 50bp to LIB+600 with a 94-95 OID. The upward flex was already eating into banking fees—which typically range from 2 to 3 percent of the total deal size—but the pain didn’t end there for Blackboard’s bankers. In order to compete with the rich yields offered in the secondary market, Blackboard would later drop its OID to 92.
“There’s only one problem with competing with secondary market yields,” said another capital markets banker. “It’s a moving target.” Alternatively, index-based flex language is designed to provide a systematic approach to pricing, similar to a leveraged-based step down pricing grid, sources said.
Index-based pricing is nothing new. The addition of index-based pricing was talked about in 2008 and again 2009 when there was no visible bottom in the loan market and banks were committed to syndicate mounds of loans. Noted one portfolio manager: “In both instances, the strategy gained no traction.”
But the idea has once again resurfaced as volatility in the loan market has increased and the prospect of hung deals hangs in the air. “Bankers were spooked when the first hung deal, Lawson Software, occurred in June,” said one portfolio manager. Lawson Software was acquired by Infor Global Solutions and
And as banks look to limit their exposure to losses on hung deals, the pitch for index-based pricing is once again making the rounds.
(Clinton Townsend is a correspondent for Thomson Reuters LPC in New York.)