Banks are offering loss-making discounts on a raft of large U.S. leveraged buyout loans, in an effort to make the deals competitive against low secondary spreads, according to sister service Thomson Reuters LPC, which tracks the loan market.
Facilities being offered at a discount were underwritten before August’s volatility and include a $780 million loan for education software maker Blackboard, which is being bought for $1.64 billion by
The moves, which demonstrates pessimism about market conditions, are cutting deep into banks’ fee income and could bring losses if further concessions are required on the deals in the market, as well as a $14 billion forward calendar of leveraged buyouts and M&A transactions—including a $1.2 billion term loan for the health-care payment processor Emdeon, which has a $3 billion buyout deal with The
Mezzanine lenders have already been put on standby in case any of the deals need structural adjustments. Some banks are also starting to talk about cross-selling some of the forthcoming deals to high-yield and equity investors if deep discounts fail to tempt loan buyers.
To ease investors’ fears about taking credit risk in a volatile market, the Blackboard and Telx Group loans were initially offered at deep discounts below banks’ fee levels of around 2 percent to 3 percent and coupons were also raised. Banks usually only offer deep discounts at the end of syndication after exhausting other options.
Blackboard was forced to widen the original issue discount for the second time on its first term and second-lien loans to 92 and 90 respectively by late September, although it maintained its coupon at 600bp over Libor on the first term loan and 1,000bp on the second-lien loan. Both tranches have a 1.5 percent Libor floor.
The highly leveraged, B2 rated company first offered to widen its discount to 94 to 95 compared with a discount of 96.5 to 97 cents at launch, a level that was already painful as banks typically break even at around 96 and discount levels of 92–90 indicate losses, bankers said.
“Arrangers need to pick the lesser of two evils on these deals in the pipeline,” said an investor. “Either delay syndication further and hold the loans on their books, or take losses from syndicating deals at deep discounts in the current market. I think we’re hearing from banks that they’d rather do the latter.”
Flex language is included in underwriting commitments to help banks to adjust loan terms to suit demand. This can include an interest rate cap on the total yield, including the loan coupon and discount, or deals can be structured with separate rate caps on the loan coupon and the discount—the OID.
Agent banks usually have to bear the cost of issuing a loan at a wider discount than the flex language allows, which can involve breaking even or losing money on a loan. Lead arrangers on the left of deals usually bear bigger losses than other arranging banks. “When you go outside the flex language, the bank is eating the loss out of its fees,” said a banker.
Although some banks may lose money on the current crop of deals, those losses may be bearable, one leveraged loan banker said. “Even if banks lost three points on $10 billion of loans in the calendar, that’s $300 million spread across banks,” he added.
Blackboard’s loan was fully underwritten by Bank of America Merrill Lynch, Deutsche Bank and Morgan Stanley. Bank of America Merrill declined to comment.
Blackboard’s loan has set a high pricing benchmark as the leveraged loan market slowly reopens after a slump in secondary loan prices in August. Between Aug. 1 and Sept. 20, average secondary bids dropped to 92.56 from 96.05, boosting the yields on loans trading in the secondary market.
Primary market issuers have had to offer premiums in order to get deals competing with low secondary prices past the finish line. Wider discounts ensure that new-issue loans have enough of an upside in a falling market and don’t trade lower than their issue price—which, not surprisingly, deters investors.
“If you sell at 98 and secondary comps are trading at 94, the loan will experience selling pressure and eventually trade lower, and that doesn’t look good,” said another banker.
Private equity issuers favor higher discounts as they are cheaper than raising the coupon on loans that may take time to refinance at lower rates. “It’s much easier for issuers to give on OID because, right now, they don’t know how long it will be before they can come back to market to refinance high costing capital,” said a second investor.
(Smita Madhur is a senior correspondent for Thomson Reuters LPC in New York; additional reporting by Clinton Townsend.)