Lenders Push Back, Borrowing Costs Rise

A raft of companies, including privately held Toys R Us, have scotched plans to refinance bank loans of late as borrowing costs have risen in the market, in an early sign that capital markets may be weakening, according to Thomson Reuters IFR, a sister publication of Buyouts.

A massive earthquake in Japan threatens the global economy and has made investors less willing to take credit risk, particularly in loans made to riskier companies, known as leveraged loans. The recent deal cancellations could just be a hiccup, but if the loan market continues to weaken, the pace of merger deals and leveraged buyouts may slow. “People have been reminded of the uncertainty and instability of how fragile things can be,” a portfolio manager said.

Toy seller Toys R Us, owned by Bain Capital, Kohlberg Kravis Roberts & Co. and Vornado Realty Trust, tried to refinance a $1.1 billion bank loan, but decided not to, because it would be too expensive. Likewise, Asurion—a portfolio company of Madison Dearborn Partners, Providence Equity Partners and Welsh, Carson, Anderson & Stowe that provides insurance against wireless devices being lost or stolen and that merged in 2008 with N.E.W. Customer Service Cos., an administrator of product warranties owned by Berkshire Partners—pulled a $4.5 billion loan, citing market conditions.

Bank loan investors largely shrugged off earlier signs of potential trouble in the global economy, including the rising oil prices that followed Middle East tumult. But the earthquake, combined with previous difficulties, has changed the market, investors said. “Issuers have recently pulled back aggressive deals, waiting on the sidelines as Japan adds to growing macro concerns,” said Gautam Kakodkar, credit strategist at Barclays Capital.

Other companies, publicly traded and private, including Swift Transportation, MedAssets Inc., payments processor Fifth Third Processing, and food industry marketer Advantage Sales and Marketing have similarly withdrawn deals recently.

The loan market is enormous, with U.S. banks having more than $1.2 trillion of loans to companies outstanding. But many of those loans do not trade actively, and are not syndicated. The volume of syndicated bank loans was about $59 billion in the 12 months ended March 2011, according to sister data service, Thomson Reuters LPC data. About $29 billion of that was leveraged loans.

Many in the market view the loans being pulled as little more than a blip. The loan market had grown increasingly tolerant of features of loans, such as so-called “covenant lite” terms, that give borrowers more rights at the expense of lenders, but that seems to be shifting. “If (a borrower) is not under pressure to close this week, why not wait two weeks and see if you have a better shot of getting covenant lite or whatever it is,” said Brett Barragate, co-head of the banking and finance practice at law firm Jones Day in New York.

With central banks globally having boosted the money supply, investors have ample funds to put to work, and loans have been seen as an attractive place to invest. Most loans are floating rate, meaning they can perform well if inflation rises and interest rates start rising. And loans are usually secured by assets, unlike corporate bonds, making them attractive to risk-averse investors seeking yield, even if the borrowers do not have investment-grade credit ratings.

Loans have helped fuel leveraged buyouts and big merger deals. Thanks in part to the loan markets, leveraged buyout executives say that $10 billion to $15 billion buyouts are possible again, after having been inconceivable just 18 months ago. Toys R Us decided that its cost savings from refinancing a bank loan would be insufficient at current prices. Given the negative sentiment in the market and the fact that the deal was not imminently necessary, the company decided to wait until market conditions improve to re-launch the deal, sources said.

Soon after Toys R Us withdrew its deal, healthcare data processing company MedAssets pulled a $635 million term loan targeted to institutional investors. Payments processor Fifth Third Processing withdrew a $1.775 billion refinancing as well. Trucking company Swift Transportation scotched a $1.07 billion loan, and Advantage Sales & Marketing withdrew a $1.225 billion deal, amid lenders’ pushback.

Loan trading in the secondary market has also weakened, which lifts the rates that companies have to pay on new loans. Many participants hope that the weakening of the loan market is temporary, because defaults are still low and loan funds continue to receive funds from investors. However, the amount of negative news keeps accumulating and it is unclear whether it could lead to a more pronounced downturn, investors said.

Michelle Sierra Laffitte is a senior reporter at Thomson Reuters IFR. Caroline Humer also contributed to this report.