U.S. leveraged loan lending slumps in volatile third quarter

By Lynn Adler

NEW YORK (Reuters) - Market volatility drove US syndicated lending down 29% in the third quarter from the prior quarter, and year-to-date funding down 12% to a three-year low, Thomson Reuters LPC data shows.

Concerns about China’s economy and uncertainty about Federal Reserve policy, the main sources of volatility in the quarter, are expected to persist and restrain syndicated lending at least through year end, bankers and investors said.

A reach for higher-quality assets pulled investors into loans from high yield bonds, and into higher-quality loans from riskier ones.

“We’ve been moving up in credit quality in our portfolios,” one investor said. “If the Fed is concerned enough about trying to delay their rate hike then we’re probably supposed to be worried as well.”

The Fed refrained in September from raising rates for the first time in nearly a decade, citing global economic pressures and low US inflation.

Floating-rate loans offer a hedge once interest rates do rise, and provide the protection of being higher in the capital structure.

“We’ve been moving more, where we can, into loans over high yield bonds, just given the fact that the loan market has a better supply/demand technical and less exposure to energy, oil in particular,” the investor said.

The reach for quality by more selective investors played out in a bifurcated loan market, with investment grade borrowing up and leveraged lending down.

Leveraged lending has also been constrained by heightened regulatory scrutiny of loans backed by significant amounts of debt.

US syndicated loan issuance fell to US$401bn in the third quarter from US$563bn in the second quarter, and to US$1.35trn for the first nine months of the year from US$1.53trn in the same period last year, according to LPC.

In the investment grade sector, lending rose about 6% from the second quarter to US$204bn on a solid mergers and acquisition pipeline set in motion earlier this year.

Third-quarter investment grade M&A volume matched the amount of the first two quarters combined, though it is widely seen slowing through year-end. For the first nine months, total investment grade lending volume reached a four-year high of US$575bn.

In contrast, leveraged lending so far this year is at a three-year low of US$537bn, down 28% from the same period last year.

DEMAND TRUMPS VOLATILITY

“Clearly there has been a lot of volatility, but it has been more muted in loans than for high yield bonds,” said Sarang Gadkari, head of US leveraged finance at Bank of America Merrill Lynch.

“From a supply standpoint, there has also been a relative dearth of new institutional loan issuance, which, when combined with the CLO demand, has led to less volatility,” he said.

Collateralized Loan Obligation funds, CLOs, are the largest buyers of leveraged loans. This year’s CLO fund creation totals US$78.6bn, 16% below last year’s record pace, but plentiful enough to help absorb the lower available loan supply and compenstate for weak retail demand.

Insurance deals were among the largest investment grade loans in the quarter, including Anthem Inc’s US$30bn in loans tied to its acquisition of Cigna Corp, and Aetna Inc’s nearly US$30 billion in bridge loans funding the acquisition of Humana Inc. Aetna in August entered into a US$3.2bn term loan that partially took out some of the senior unsecured bridge facility.

Large leveraged buyout financings in the quarter included a US$1.54bn Alliant Insurance Services credit facility backing an investment by private equity firm Stone Point Capital; a US$1bn facility backing the buyout of smart card component maker Linxens by private equity firm CVC Capital; and a US$635m facility for transportation and logistics company Quality Distribution’s buyout by private equity firm Apax Partners.

“Overall, the supply of new paper continues to be very disappointing, but is positive for valuations considering how little supply is coming,” the investor said. “Banks just don’t want to take risks right now, so I think net supply is going to be fairly constrained at least through year end if not into 2016.”

(Editing By Jon Methven)

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