US investors bet on risky borrowers in search for yield

By Aaron Weinman

NEW YORK, July 29 (LPC) - Low-rated borrowers are prying open a window of opportunity to raise money in the leveraged loan market as a dearth of higher-rated deals has investors seeking returns from a riskier corner of the US credit markets.

At least six companies rated B3 by Moody's Investors Service launched loans in July, but have done so with highly attractive coupons that have enabled these deals to sail through the syndication process.

Higher coupons are quickly becoming the new normal for lower-rated borrowers. In recent months, these companies have struggled to attract heavy interest from risk-averse investors wary of companies' debt being downgraded by ratings agencies.

Since the onset of the coronavirus pandemic loan defaults have soared and companies have drawn down existing credit lines or tapped capital markets for emergency funding.

This month, however, a lack of higher-quality, Double B rated loans has granted Single B borrowers greater investor attention. Albeit at a steeper cost, these companies have seized on this momentum and raised loans that have repayed recent borrowings, funded acquisitions or extended maturing debt.

In July, produce company AgroFresh finalized a US$275m loan at a rate of 625bp over Libor to amend an older deal that paid just 475bp and extended the maturity of the loan by three years to 2024, according to one banker.

Earlier in the month, aftermarket automotive company First Brands offered investors a lucrative 750bp margin for a US$810m incremental term loan to fund an acquisition, a second banker said.

The average margin of a drawn Single B rated term loan has increased to roughly 460bp over Libor in July from 390bp at the end of February, according to data from Refinitiv LPC.

Single B borrowers are the most exposed to downgrades into Triple C territory, which is just a few notches above default.

BMO Capital Markets led the deal for AgroFresh and Jefferies arranged the loan for First Brands.

Spokespersons for the banks, AgroFresh and First Brands were not immediately available for comment.

“B3s are definitely making a comeback. These businesses can get deals done, but it will just cost them a bit more right now,” said Michael Marzouk, managing director for bank loan strategies at Pacific Asset Management.

NEW LOW

Loan quality fell to a new low in the first quarter this year and may worsen, according to Moody's Investors Service. The ratings agency's Loan Covenant Quality Indicator, a measure of investor protections, weakened by 8bp to 4.3 in the first quarter of 2020 compared to the prior two-quarter period. At 4.3, this score, measured from one to five, with five indicating the worst possible protection levels, is the highest it has ever been.

“Borrowers have expanded the set of tools to alleviate their credit stress at lenders’ expense,” Moody’s analysts wrote in the report on July 28. “They also retain several options not yet widely deployed…which could present serious complications for secured lenders.”

MEAGER SUPPLY

As lower-rated borrowers fill the market, at the heart of the matter is a lack of higher-quality supply.

Investors, particularly Collateralized Loan Obligations (CLOs), are clamoring for higher-rated loans for businesses with greater cash flow that can withstand bouts of uncertainty brought on by the pandemic.

But with little in the way of top-quality leveraged loans, portfolio managers must weigh the risks and rewards of these Single B rated companies, particularly against the backdrop of economic volatility.

CLOs, the single-largest buyer of new loans, remain wary of stuffing their vehicles with B3/B rated loans as downgrades to Triple C can trigger tests within the CLO.

CLO new issuance volume in June was at its highest since Covid-19 gripped capital markets back in March, according to LPC Collateral data. For June, 21 CLOs raised US$8.2bn, 37% more than May, and investors are under pressure to fill these vehicles with new loan facilities.

“Folks that raised new CLOs need to put money to work and find the necessary paper,” said an investor that focuses on performing loans. “There is not much else in the market right now, so this limited, lower-quality stuff gets an audience.” (Reporting by Aaron Weinman. Editing by Michelle Sierra and Chris Mangham.)