• Market saw $1.14 trln issued in 2013
• Issuers to cut costs, exend maturities
• Risk retention rules may chill CLO market
Issuers will continue to take advantage of low borrowing rates and robust loan demand to cut costs and extend maturities, according to banking sources. However, issuance is expected to expand from repricing and refinancing into other uses of proceeds, including mergers and acquisitions.
Nearly 70 percent of loans were earmarked for refinancing or repricing in 2013.
“With the maturity wall having been pushed out, and a lot of the opportunistic refinancing having occurred, it’s doubtful we’ll reach 2013 highs,” said Leland Hart, head of the bank loans team at BlackRock. “But that said, it’s easy to continue to refinance loans, and it’s nice to see that M&A is starting to pick up, and that should provide a new source of fresh capital needs from borrowers.”
Enhanced credit profiles, an uptick in capital expenditures from low levels in 2013 and a low default environment are also expected to support another year of healthy loan issuance.
Insatiable leveraged loan demand in 2013 largely stemmed from investors starving for yield and aiming to hedge against an eventual rise in short-term interest rates.
While the Federal Reserve has set expectations for measured tapering in 2014, estimates vary across Wall Street for when the Fed will fully complete its asset purchases, or when the Fed will begin raising short-term interest rates. Timing uncertainty around rates and potential market response are expected to continue supporting demand for the floating-rate leveraged loan product.
Strong demand trends led to a borrowers’ market in 2013.
In addition to the waves of repricing, issuance included a record $311 billion in institutional covenant-lite loans that more than tripled the prior record, according to JP Morgan. Covenant-lite loans offer less protection for investors.
The effect of new collateralized loan obligation (CLO) regulations on the leveraged loan market is a wild card. Risk retention rules outlined by the Dodd-Frank Act may chill the CLO market by lowering their demand for new loans.
However, CLO issuance could be pulled forward in 2014, according to a Barclays report, as these requirements would only become effective two years after the final adoption of the rules.
A Citi report says that Fed and Office of the Comptroller of the Currency (OCC) regulatory pressures on banks to increase lending standards could weigh on loan issuance this year. Regulatory pressures may restrict private to private leveraged buyout (LBO) deals more than public to private LBO transactions in 2014, given that the former carry higher leverage.
“Deteriorating lending standards have caught regulators’ attention, particularly in the loan market,” the Citi report said. “We believe this will shift some lower-quality (loan) supply to the bond market if the use of issuer-friendly features (such as covenant-lite packages) is more closely regulated.”
However, Hart notes that the OCC suggestions may be positive for investors, as it helps reel in looser structures from borrowers.
“The average deal of today is still better than the average deal of 2006 or 2007,” said Hart. “When you have things like the OCC coming in and making suggestions around underwriting standards, that will actually be a positive force in future performance of loans.”
By the numbers
Citi analysts in a December research report expected loan supply to be down 15 percent, as the regulatory focus on lending standards drives some issuers out of loans into the bond market.
JP Morgan forecast institutional loan issuance, which includes loans marketed to institutional investors, will drop roughly 35 percent in 2014 given the hefty volume of loans already refinanced or repriced in 2013.
Bank of America Merrill Lynch forecast a roughly $10 billion uptick in gross institutional loan issuance in 2014 (excluding repricings), versus 2013, supported by a pick-up in M&A and LBO activity.
In a December roundtable, Barclays noted continued demand for the leveraged loan asset class driven by rising interest rates and strong technicals. Barclays anticipates roughly flat leveraged loan volume in 2014, again given significant refinancing loan volume already pulled forward into 2012 and 2013.
Natalie Wright is a reporter for Thomson Reuters LPC in New York