“I passed on the majority of deals that I saw in the past two months,” said a second buysider. “It’s partly because we aren’t so interested in small deals, but there’s also been a lot of challenging names recently.” 

“I think going back two to three weeks ago there were deals pricing wide,” said one sellside source. “It is a combination of small deals: if there is a smaller offering, not always, but in a lot of cases people ask for a bit of a premium anyway.”

This has been tempered, however, by increasingly chunky allocations — a welcome change, buysiders report, after struggling for scraps earlier in the year. “We’ve seen a huge improvement in allocations,” said a third buysider. “The first half of the year was pretty dire and you ended up playing some borderline deals because you weren’t getting the allocations you wanted on the better deals. It’s the same at the biggest shops and for the small guys.” A fourth buysider concurred: “What was 20% is now 50%, what was 50% is now 70%.”

“I think that it is true that oversubscription levels have been decreasing during the year,” said the sellside source. “It’s a mixture of cash and wanting to buy. Some recent processes we launched had still had big managers putting in what I think looks like typical ticket sizes; if people like something there is not a shortage.”

Breaking the 400 barrier

Despite mixed feelings on the state of the market, buysiders agreed that post-summer margin gains are an earned (if partial) correction to early 2021’s paltry pricing. “It’s important for banks and sponsors to acknowledge that the market is a touch sweeter [for investors] than it was pre-summer,” the second buysider said. “You can’t expect pre-summer pricing.”

Single B loans have settled at an average of E+408 bps as of October after lows of E+375 bps in January, according to 9fin data. Our numbers further show BBs also rocking through the 400 bps barrier, albeit misleadingly dragged up from the apathetic reception of UK equipment firm Aggreko’s October offering: its $750mand €500mdeals priced roughly 100 bps above guidance (E/L+425-450 bps). Wiping this somewhat-outlier from the records gives an average of E+325 bps for the BB bunch, up from average lows of E+275 bps at the start of the year.

Splitting up Single B loans, we see the biggest rise in B2 loans. To look at those most populous of ratings, B2 loans have trended up to a cosy E+400 bps post-summer and appear to be staying there, now over two months later, with OIDs settling down just below 99.4.

“People will buy at 400, the question is if people can come at 375,” said the sellside source. “I don't think it is different from the pre-summer period [...] The market is pretty healthy and average yields have not necessarily gone up.”

Correspondingly, more deals are coming in at the wide end of guidance and are frequently dragging on past initial commitment dates. Late-comers include luxury watch brand Breitling’s €890m 2028 TLB (B2/B) and the €305m TLB (B/B2) supporting Towerbrook's acquisition of office supplies firm Bruneau.

These late pricings sometimes correspond with speedy commitment deadlines, buysiders report. “Banks are increasingly giving us less time to look at deals and expecting us to use our weekends to look at deals — launching on a Friday and booking one-on-ones for the Monday,” said a fifth buysider. A sixth buysider gives the example of Synthon’s €360m TLB, which priced at E+450 bps at the beginning of November.

Recent deals coming in at the wide end of guidance include Norway-based satellite Marlink last week (E/L+275 bps on its $525m and €250m tranches), with buysiders cold on its Chapter 11-laced history. Seqens’ €830m 2028 TLB also came at the wide end at E+450 bps and Restaurant Brands Iberia’s €538m TLB E+400 bps in the last weeks of October.

In another sign of shifting market conditions, Spanish telecoms firm Masmovil (B2/B)pulled its €2.2bn repricing (B1/B/BB) of an E+425 bps 2027 loan, inked in July 2020, “due to market conditions”. The loan was not only considerably larger than other deals in the market, but also paid noticeably lower at E+375-400 bps.

Small, not mighty

Several buysiders argue that these new, shiny 400-handles are down to a rash of sub-€400m deals clogging the market. The average euro leverage loan tranche issued in September was the year’s second lowest at €437m (after August’s €366m), with the year’s highest proportion of sub-€400m deals at 60%.

“I don’t buy that there is something going on in the wider market. Most of this looks idiosyncratic to me,” said the fourth buysider. “CLO dynamics are always relevant, but we’ve had a lot of €300m deals in niche industries which do need to come at a bit of a premium to larger deals and familiar names. And once that becomes the market norm, it’s the market norm. Others need to come there too.”

A seventh buysider concurred: “If you look at the individual names that have come to market in recent weeks, those were never going to be very convincing.”

“You can pick on supply chains, business specifics and decide you need premium, but there is not an overreaching macro reason why pricing should get wider on everything,” agreed the sellside source.

Buysiders named deals such as Netherlands-based TenCate Grass, Belgian firm The Cookware Company and office supplies firm Bruneau as examples of this. The first two flexed, appropriately, wider: TenCare Grass conceded 25 bps and one-point on its margin and OID to E+500 bps and 98.5 on its €315m TLB (B2/B); The Cookware Company gave up +12.5 bps to E+487.5 bps to finally close its €348m TLB on 19th October after initial commitments of 14th October.

“These are the companies who’ve been waiting in the wings to come to market but were waiting for the bigger deals and the bigger names to be digested first,” said the first buysider. “So we’ve just had a rush of them in recent weeks.”

“Another problem with these small deals is that they take up the same amount of time as any other deal but don’t fill your books, which makes them a low priority” said the first buysider. “The reality is that sometimes you just don’t have time to look at a deal and it’s the small ones that are the first to go.”

“Three weeks ago, there were deals that people didn't want to play and that could have made them scale back,” admitted the sellside source. “I think there are less underwritten transactions on everyone's books right now and no definitive pipeline of big LBOs before Christmas.” 

Some buysiders also argue patchy credit quality has been a trend this year beyond the smaller deals. “Sponsors are flush with cash and are pushing companies to expand into new regions or consolidate their positioning through M&A — there’s a taste of opportunism with many deals this year, which has meant a drop in quality, though I expect that to taper off,” said the second buysider. 

Ratchet rumbles

Buysider weariness with increasingly aggressive margin ratchets is also coming into play, some investors report. “The majority tried for three ratchets down and some of them got it. Those need to be priced in,” said the eighth buysider. “Often what they define as leverage is pretty cheeky anyway, so some companies are hitting those targets quickly. ”

“It’s a song-and-dance now, knocking those three ratchets down to one,” said the third buysider. “I suppose it keeps our attention there and not elsewhere in the docs. As long as everyone holds firm to rejecting them, it should be fine.”

This year’s prevalence of ESG ratchets (that are often easy to hit) also need to be priced in, several buysiders argue. “Even 5 bps matters if it’s suddenly on every deal that’s coming to market,” said the first buysider. “So far not too many targets have been impressive, so we’re expecting most of them to hit them. Some are coming with metrics they’ve already achieved. But that just means we’re going to want to be paid more to offset that, especially if we don’t really buy the ESG worthiness of the KPIs.”

“I think generally the market was okay with the ESG ratchets, but I totally agree that people want them to be meaningful, not instantly achieved,” said the sellside source. “We have done a lot of work to not be complacent. We don't want people to say that something is greenwashing, but it is still not a huge discussion in syndication.”

CLOs slide alongside

Behind any soft leveraged loan market is a soft CLO market. While AAA spreads came in tight between 91 bps and 87 bps between January and June 2021, the months since then have shifted up to between 95 bps and 101 bps, with both August and September breaking the 100 bps barrier, according to LPC and Finsight data.

All else being equal, CLO spreads and leveraged loan spreads ought to have a relatively tight relationship, as tighter CLO debt liabilities allow CLO managers to buy loans at tighter spreads and still generate a return for equity. As a rough rule of thumb, around 200 bps between CLO cost of debt and loan spreads is comfortable, allowing CLO formation to keep running and markets to remain balanced.  

This year, as the chart shows, the relationship has been a bit more complex. Both markets rallied in tandem in the first quarter, but the softening CLO market over the summer was not matched by a comparable softening in new issue leveraged loans, while more recent loan market weakness has come as CLOs have started to tighten again. 

“You can feel the difference between early 2021 and now,” said a ninth buysider. “The market was very attractive for CLOs in Q1. Generally, we price in the middle of the pack and it’s been a move from the 80s to the 100s.”

Some of the explanation is likely down to market technicals. There are relatively few investors active at the top of the CLO capital structure, so the presence or absence of certain large players can determine pricing to a high degree. At the beginning of the year, the withdrawal or rolling off of Japanese anchor accounts was matched by some large US money center banks pushing into the market, but by the summer, the record levels of supply, both in new issue and in resets, had led to some fatigue and greater selectiveness emerging in CLOs.

Some of the summer fatigue in loans, meanwhile, may not be fully captured by our dataset, which looks at priced offerings. The postponement of Spanish waste management firm Urbaser's planned €1.63bn term loan at the end of July certainly signalled to some market participants that conditions had been running too hot for too long, but we never saw the market-clearing level for the offering, until it returned with a recut capital structure against the stronger backdrop of September.

Lag effects may also help to explain the divergence — CLO formation takes time, in other words. Conditions at the beginning of the year suggested strong CLO arbitrage and good equity returns ahead, which may have contributed to the glut in supply and softening over summer. By contrast, new leveraged loan supply is driven more by sponsor activity and M&A, which requires constructive financing conditions, but isn't particularly sensitive to relative value in debt markets or the details of financing terms.

A step back

Elsewhere, some buysiders dismissed market-specific factors, finding every explanation in the macro. Chief among them was rising inflation across much of the developed world, they said, as well as global supply chain snags hitting companies’ recent earnings.

The ninth buysider said: “Energy costs are something I’m worried about. Natural gas prices are soaring to record levels across Europe ahead of winter. It’s another thing that makes you cautious when you’re looking at a deal, thinking about those costs to come, those numbers coming out in January.”

Others agreed. “Everyone is waiting for the next mini cycle, not another pandemic — thank god — but the next disruption,” said the fourth buysider. “Inflation, supply chain issues — there’s plenty to pick from.” 

“Earnings have been coming in with all these aftershocks from different directions and so a decent chunk of our portfolio did move accordingly,” said the first buysider. “There are more opportunities in the secondary market now than there were in the first half of the year.”

“On top of that, you’ve had Evergrande starting in April and, by now, there’s a real crisis there. This is 3% of the Chinese index so when those BB/B real estate Chinese bonds widened, that also had a catastrophic effect on the market,” said the ninth buysider.

Buysiders argue that these drivers, beyond the leveraged finance market, are behind the softening in the secondary market. Unlike in H1, when every week-on-week analysis delivered incremental pricing bumps, post-summer has tracked weekly slips in secondary movements. 

The only buoyant sectors tracked by 9fin (Hotels, Resorts & Cruise Lines; Automotive Manufacturer, Software & Services; Construction & Engineering) are kept afloat by Covid-resiliences, Covid-rebound or individual names.

“I think the market will stay this way for quite some time,” the ninth buysider said. “We’ll see if there’s a correction. This still isn’t where I’d want the market to be: if this was a strong market, B2s and B3s would be coming in at 5-handles. But too much of what is making the market jittery is far beyond our little sphere and it’s not likely to settle down for some time.”

“There isn't much right now, only a few big M&A trades that less people know about,” the sellside source said, joking: “Maybe the buyside also appreciates the break having a bought a lot of stuff earlier in the year.” On the upcoming pipeline, they said: “There are a bunch of M&A situations for 2022. They are signing up right now and coming early 2022, but completion of M&A is still little bit away.”

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