Record $1 trln in loan refinancings in 2013 despite Q3 slowdown

Verizon’s M&A financing helped boost 3Q13 U.S. investment grade loan issuance by 55 percent year over year and 23 percent over 2Q13 to $217 billion, according to Thomson Reuters LPC. 3Q13 U.S. leveraged loan issuance, at $204 billion, is up 59 percent year over year, but down 41 percent from 2Q13’s record as the pace of refinancings slowed.

Verizon and Dell’s loan financings demonstrated the possibilities and capabilities of financing in the U.S. loan market, leaving underwriters with hopes that companies will be encouraged to pull the trigger on long-awaited transformative transactions.

The deals were easily sold to a widely divergent investor base, soaking up pent-up demand for new issue supply in markets dominated by refinancing activity.

In the leveraged space, loan issuance has reached $848 billion in 2013, beating 2007’s record by 23 percent, according to Thomson Reuters LPC. However, M&A-related leveraged loan issuance, at $146 billion, remains 60 percent below 2007’s $357 billion peak. With M&A slow to pick up amid strong investor demand, refinancings reached a record $583 billion, making up 69 percent of leveraged loan issuance.

Repricings, where issuers cut spreads alone, reached a record $108 billion, regaining momentum in September as single-B all-in spreads slid to 533bp from 568bp in August. Investors are discerning based on quality, however, as 25 issuers flexed spreads down by an average of 40bp in September while 12 issuers flexed up by an average of 90bp.

The covenant-lite structure prevailed with a record $188 billion in 2013. Forty percent of assets held by 2012/2013 vintage U.S. collateral loan obligations (CLO) are now covenant-lite, according to Thomson Reuters LPC Collateral.

In the first quarter, $27 billion in CLOs priced, while $17 billion and $14.5 billion in CLOs priced in the second and third quarters, making 2013 the fourth most prolific year on record. However, $60 billion in CLOs are also reaching the end of their reinvestment periods in 2013. Coupling this with refinancings and redemptions, CLO outstandings have remained flat at $285 billion.

CLO issuance slowed in the second half of the year as banks digested new FDIC assessments, the arbitrage became more challenging amid volatility and tightening in loan spreads, and a lack of AAA investors. Conversely, flows into loan retail funds have been fast and furious, surpassing $52 billion this year, compared to $7.8 billion in outflows for high yield bond funds, according to Lipper FMI. Loan mutual fund assets under management climbed to an all-time high of $143 billion by the end of August.

In addition to traditional retail and closed-end funds and CLOs, investors are also gaining exposure to loans through separately managed accounts and commingled funds. New investors in the U.S., Japan, South Korea and Western Europe are enticed by loans’ floating-rate characteristics, the cash coupon, low duration and moderate risk-adjusted yields. Institutional demand has grown from pension funds, endowments, family offices, insurance companies, high net worth clients, trusts, high yield bond funds, hedge funds and sovereign wealth funds.

But banks are also hungry for assets. At $109 billion, 3Q13 leveraged pro rata or bank loan issuance is the second-highest on record following 2Q13’s $154 billion and up 62 percent year over year.

At $523 billion this year, investment grade lending is up 20 percent compared to the same period last year. Of this, $105 billion was M&A-related, including a $49 billion bridge loan that was part of the financing backing Verizon’s buyout of Vodafone’s stake in Verizon Wireless.

Ranking as the biggest bridge on record for the investment grade space, it was replaced with a $49 billion bond that priced on September 11 with demand in excess of $100 billion. The same day, a $6 billion, three-year term loan and a $6 billion, five-year term loan launched to general syndication.

Term loan issuance picked up with an additional $14 billion in the third quarter, rivalling only 2Q07’s $28 billion record and lenders expect the trend to continue.

Ioana Barza is an analyst for RLPC in New York