Bank of America Kills it in Leveraged Finance Q1-Q3
The leveraged loan and high yield markets are currently on fire! Issuance is up 30% yoy, despite 2009 being a very strong year in issuances. Bank of America was leading the charge in market share, beating JPMorgan and taking 24%. JPMorgan, the nearest bank was only at 14% market share, due to its conservative underwriting standards.
According to Ioana Barza of Thomson Reuters, "The U.S. syndicated loan market is firing on all cylinders heading into the fourth quarter. Although increased volatility is becoming a market staple and poses challenges for underwriters, the upside is that loan issuance has rebounded on the back of a strong bond market.
Lending activity in 1-3Q10, at $716.5 billion, was up 92% from the $372.8 billion in the same period last year, and up 30% over full-year 2009 levels, according to Thomson Reuters LPC. Although refinancing activity has driven roughly 70% of U.S. loan issuance this year, the pickup in activity in the third quarter has been dramatic. At $226 billion, 3Q10 volume is up 131% from 3Q09.
While lending has been stepped up, 63% of senior buyside and sellside lenders surveyed by Thomson Reuters LPC said constraints to get deals done remain as financings are still getting done selectively. Only one-quarter of respondents believe there are now few barriers to getting deals done, and a meager 12% said risk aversion runs high at their institutions and they are somewhat constrained.
After slowing to a crawl in May and June, the high yield bond and leveraged loan markets made a strong comeback in 3Q10. As investors regained their footing, many sought refuge in fixed income. High yield bond issuance surpassed 2009's full-year record of $146.5 billion, with $173 billion in volume through Sept. 29. Investors followed the relatively attractive yields and bond fund inflows recovered after the dramatic pullback in the spring on the back of the Eurozone debt crisis and fears of a U.S. double dip recession.
2010 mutual high yield bond fund flows (including funds reporting monthly as well as funds reporting weekly) stood at +$7.681 billion, through late September, according to Lipper FMI, a Thomson Reuters company. Just as investors voted with their feet with $4.6 billion in outflows in the spring, there have been over $8 billion net positive inflows since mid-June.
With record inflows and bond issuance, it is noteworthy that nearly 40% of bond proceeds were used to pay down loans this year. While this virtuous cycle came to a halt, with less than $4 billion in monthly paydowns in May, through July, bond-for-loan takeouts climbed to the $9 billion range in August and September. With this extra cash from pre-payments to reinvest back into loans, CLOs made a slow comeback (albeit with recycled liquidity) and secondary loan bids began to climb, and continue to grind higher.
At the end of 2Q10, the SMi100 average bid was down over 2 points, while gaining 2 points in 3Q10. However, investors continue to be somewhat selective. Loans originated post-crisis (i.e. 2008 to present) remain higher bid relative to the 2006-2007 vintages. In fact, roughly 70% of 2010 vintage loans remain bid between 98-100, thanks to bells and whistles like call premiums, LIBOR floors and OIDs.
With these names already highly bid, investors began to focus on the primary market in hopes of a lineup of new issue. And after Labor Day, they got just that as the institutional pipeline doubled in size, deals were launched one after the other and many were oversubscribed. All told, leveraged issuance reached $75 billion in 3Q10, up 50% over 3Q09 volume on the back of new issue, which was $43.37 billion.
Equity sponsors became increasingly active, pursuing dividend recaps and financing a number of large LBOs. As a result, sponsored issuance reached $41 billion, with $16.5 billion in the form of LBO financings. There was a smattering of covenant-lite deals and nearly $5 billion in dividend recap financings in 3Q10, spread across 11 deals - a sign that arrangers were ready to test risk appetite again. However, the $12.5 billion total volume of dividend recaps done so far this year is on par with what was done in a single quarter in 4Q06 and 2Q07. Lenders expect this trend to continue with recent announcements for Metaldyne, Angelica and Euro-Pro.
New deals have been successful in attracting a range of investors and yields have begun to recede, with $15 billion in facilities flexing down in 3Q10 (versus $6 billion in upward flexes). On average, issuers saw primary yields (including Libor floors, contractual spread, and OID amortized over four years) come down to 6.95% in September from 7.67% in August.
Although loan yields are coming down in the primary, they remain attractive - and not just to CLOs. Crossover investors are increasingly active in the space and loan mutual fund inflows have surpassed well over $6 billion this year. Investors plowed money back into the funds, with the largest one-week inflow of $480 million recorded in September. With strong demand, hefty oversubscriptions and downward flexes, the institutional pipeline, which stood at roughly $13 billion by press time on Sept. 30, is up significantly from where it was in August and nearly double the level in early September. Today's pipeline is still lower than the $16-18 billion highs seen in April and May, but it is widely expected to grow heading into 4Q10.
While all signs point up in terms of new issue in the leveraged loan market, lenders are not sitting back. Demand, driven by loan paydowns via the bond market, remains volatile. With unpredictable fund flows and moves in equities, which in turn move the bond market, the virtuous cycle remains fragile.
With a surge in new CLOs not expected any time soon and existing CLOs slowly going static as their reinvestment periods come to an end over the next couple of years, lenders are concerned about the financing gap and their ability to address the refinancing cliff. But, for now, issuers continue to rely on the bond market for relief and lenders hope the virtuous cycle will continue in the short term.
Meanwhile, investment grade lenders grappled with Basel III and its possible implications for the loan market. Under Basel III, revolving credits, which make up the bulk of the investment grade market and are largely undrawn, are currently included in the "liquidity coverage ratio" that requires banks to hold liquid assets equal to 100 percent of all undrawn credit lines used for liquidity purposes. Under this scenario, revolving credits would become prohibitively expensive. In turn, borrowers could bypass loans altogether and go straight to the bond market, or draw down revolving credits and repay them immediately, or borrow via term loans and reinvest the cash. However, it is possible that revolving credits could be instead classified as credit facilities that would attract a lower 10% liquid asset coverage ratio.
With the implementation period pushed back, nearly 60% of senior lenders surveyed by Thomson Reuters LPC said they expect some impact on investment grade lending in the short term, although more clarity is needed around which category revolvers will fall under and nearly 40% said they don't anticipate any impact.
3Q10 investment grade lending was up 140% over 3Q09 at $78.76 billion. Although the investment grade loan market has seen an increase in volume recently, issuers continue to rely on the bond market and corporates continue to sit on excess cash. But volume was not anemic just due to a lack of jumbo M&A transactions. This has been coupled with issuers' reticence to return to market to refinance existing debt. And when they do come to market, many are downsizing. More recently, however, lenders note that as spreads have tightened, more issuers are considering coming back to the market ahead of any regulatory changes. As a result, the refinancing pipeline for 4Q10 is building.
Will issuers opt for longer tenors? Lenders say clients are just not interested in that incremental duration (or the costs that come with it) as they have confidence that they can refinance as needed, especially as demand for the investment grade asset continues to outweigh supply. Still, while three-year revolvers have increasingly become the norm, a four-year revolver market is emerging as well.
Looking ahead, lenders expect that investment grade lending in 4Q10 will be up dramatically over 4Q09's anemic levels. However, much of this will be driven by refinancing activity rather than M&A financings. Lenders expect spreads to come down across the board, given the strong demand and the absence of event-driven transactions. Already, over $100 billion in facilities have been structured with market-based pricing (MBP) this year, which has surpassed the $96 billion logged in 2009 and many anticipate this mechanism will remain in place going forward. Nevertheless, lenders note that pricing may not have found a floor because lenders are eager to put money to work and meet budgets as year-end approaches."
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