Loan Issuance Builds, Spreads Threaten To Widen

Loan volume to support mid-market LBOs in the second quarter of 2010 hit its highest level since the credit markets collapsed nearly two years ago.

The story on pricing, however, is more complicated. Leveraged loan spreads continued to decline in the lower end of the middle market, while the recent drought in junk-bond issuance may have been behind a slight increase in pricing seen at the larger end.

Mid-market lenders in the second quarter deployed about $2.9 billion in leveraged loans and revolving credit facilities to back sponsor-backed acquisitions of U.S. companies, according to Thomson Reuters LPC. That figure is the largest quarterly issuance total since the third quarter of 2008, when lenders put out nearly $4.6 billion in loans and revolvers.

For the purposes of this story, mid-market deals are defined as acquisitions of target companies with revenue of less than $500 million, in which total loan and revolver debt used in the deal also came to less than $500 million.

Liquidity only started to trickle back into the middle market in late 2009 after it suffered a prolonged dry-spell due to the collapse of Lehman Brothers in September 2008 and subsequent economic shocks. With the economy stabilizing and companies reporting earnings growth, loan issuance has picked up as both lenders and buyout shops return from the sidelines.

“In the first half of this year we started to see some new deals because the biggest obstacle—steadily declining TTM EBITDA—has been overcome,” said Lawrence Golub, president of mid-market lender Golub Capital. He added: “It’s almost impossible for buyers and sellers to agree on a price when TTM EBITDA is dropping. Now that it’s steadily going up, buyers and sellers have an easier time coming together on valuation.”

All told, lenders deployed roughly $4.2 billion in loans and revolvers to back mid-market LBOs in the first half of 2010, nearly six times the $711 million in such issuance that marked the first half of 2009, according to Thomson Reuters LPC. That said, the market today is still well shy of peak-era figures like the $23.7 billion in mid-market loans put to work in the first quarter of 2007.

Also greasing the gears for new LBOs, and hence new loan issuance, was the continued decline in pricing at the lower end of the middle market, which Thomson Reuters LPC refers to as the “traditional” middle market. That market segment, which is comprised of deals with loans and revolvers totaling less than $100 million, saw the average second-quarter spread contract to L+ 529 bps from L+ 571.5 bps in the first quarter, according to Thomson Reuters LPC.

But the recent and sudden May/June slowdown in high-yield bond issuance (second-quarter junk-bond issuance fell 30 percent from the first quarter) could be behind a slight uptick in pricing for deals in the large middle market, defined here as deals that involve loans and revolvers totaling $100 million to $500 million. Deals in the larger end of the middle market saw average spreads increase to L+ 479.2 bps in the second quarter from L+ 430.0 bps in the first quarter, according to Thomson Reuters LPC.

“We’re basically heading back to where we were five or six months ago,” in terms of pricing, said Golub. The average spread across the entire middle market in the second quarter stood at L+ 509.6 bps (see related table).