Yahoo Finance Risky Companies Have Found a $1.4 Billion Weapon to Fight a Hawkish Fed
(Bloomberg) -- A repricing wave in the leveraged loan market is helping risky companies cope with the “higher for longer” message from the Federal Reserve.
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Borrowers reworking debt to obtain better terms have saved more than $1.4 billion in annual interest expenses so far this year, according to Bloomberg calculations. Investors that have cash to put to work and are facing a short supply of new issues have snapped up the deals, producing an average margin reduction of about 50 basis points.
Delays in Fed rate cuts have left companies saddled with the fallout from the jump in benchmark borrowing costs over the previous two years. Policymakers meeting today may prolong the agony, with Bloomberg Economics expecting officials’ projections to indicate two 25-basis-point cuts this year, down from three in March. But with demand for risky credit looking set to continue, companies with ratings below investment grade may yet have scope to keep fighting back against the Fed by repricing their loans.
“Investors and issuers are taking actions to prepare themselves for higher for longer issuer rates,” said Grant Nachman, co-founder of Shorecliff Asset Management. “If issuers believe they are going to be stuck with higher base interest rates, and therefore a higher interest burden, for a long period of time, they only have so many ways of lessening their interest obligations. When the loan market gives issuers a window to reprice their obligations at a minimal cost, issuers generally take the opportunity.”
Investors with cash to put to work have been waiting patiently for new supply from leveraged buyouts and mergers and acquisitions. So far, that supply has been meager — just 7% of the $624 billion in leveraged loan issuance this year has been for deals, according to data compiled by Bloomberg. Some 90% of all leveraged loan issuance have been refinancing or repricing transactions.
To calculate the annual interest expense savings, Bloomberg took the difference between the new and old margins on dollar-denominated loans and multiplied by the amount outstanding. Not included in the calculation was the credit spread adjustment, which has been removed from many deals and could add another 10-11 basis points. The base rate, which closely tracks the Federal funds rate, is not included in the calculations. Bloomberg’s data is from the start of the year through the end of May.
The average margin reduction works out to roughly $6 million in annual interest savings. A handful of borrowers cut their spread to 175 basis points over the benchmark from around 200 basis points.
Some of the biggest winners have been risky borrowers that initially struggled to garner investor interest when their first deals were syndicated, amid rising interest rates and an uncertain economic outlook.
Cloud Software Group Inc., parent company of software maker Citrix, last month lowered the margin on its $6.495 billion leveraged loan to 400 basis points over SOFR from 450 basis points, potentially saving more than $30 million in annual interest expense. The company had to offer a steep discount on the original deal, with the loan pricing at 91 cents on the dollar.
Just a year ago, banks offloaded the leveraged loan for the buyout of payment services provider MoneyGram International Inc. at just 83 cents on the dollar and 550 basis points over the benchmark. The company repriced the loan this month at 475 basis points.
CLO Strategy
The largest buyers of leveraged loans are collateralized loan obligations, which have little room to say no to a repricing transaction as they would otherwise have to look for a new asset to buy. CLOs have been booming this year, with new issuance supply rising 78% to $93 billion compared with the same period a year ago, according to data compiled by Bloomberg. New CLO issuance could reach $160 billion this year, Citigroup Inc. strategists forecast in March.
For the repricing wave to keep running, the CLO arbitrage that rewards equity holders with high returns must hold up, said Frank Ossino, portfolio manager at Newfleet Asset Management.
While leveraged loan borrowers are cutting the interest costs on their loans, CLOs are repricing the bonds they sell to ensure returns to the riskiest holders of the debt don’t diminish. Participants at this equity level typically expect to be compensated with the biggest rewards.
The so-called equity arbitrage is the gap between the yields that CLO managers can earn on the loans they buy and what they pay to finance themselves with the riskiest securities they issue. When loan spreads become too tight, that arbitrage — the return equity holders get — can decrease. For now, there’s still room for repricings to continue without disappointing equity investors.
“I’m not happy I’m losing spread but this is what happens when you have the technical such as it is,” Ossino said. “I suspect without an M&A calendar and continued demand from retail and CLOs, there’s still room to tighten if we believe CLO liabilities have room to tighten. And consensus is that’s the case.”
Technical Factors
There are a few technical factors driving the savings. For a start, while many bonds carry a provision that doesn’t allow the debt to be repaid for at least a few years, the so-called call provision for loans is a short six months.
And for CLOs to even consider a company’s attempt at repricing, the loans must be trading above par — anything lower indicates investors are demanding a wider spread than what it’s currently paying, so it shouldn’t reprice. This makes the current environment particularly amenable to the trend. As of the end of May some 62% of the broader leveraged loan index was trading at or above par, the most since September 2018, according to Pitchbook LCD data.
“The more above par it trades, the easier it is for a sponsor or company to get a repricing,” said Young Choi, partner at King Street, which includes CLOs in its more than $25 billion of assets under management.
--With assistance from Jeannine Amodeo, Dominick Gambino and Andrew Kostic.
(Updates with context in paragraphs 12-15)
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