European leveraged loan pricing stable amid softer secondary

A lacklustre end to the first quarter for European secondary loans could suggest some of the froth is coming off the market. But demand remains strong, and rather than weakness this could point to an investor base that's better able to resist further price tightening after a heavy supply flow in the first part of the year that looks certain to continue through the spring and summer.

As monthly leveraged loan volume hit a decade-plus high in March, secondary markets began to sag a little. This softness took the average bid in the S&P European Leveraged Loan Index, or ELLI, from 98.73 on March 3 (its highest print since late 2019) to a low of 98.40 by the start of April. "The market definitely started to see some fatigue in March with the sheer number of deals on offer to look at over the last month or so," said one account.

This was no broad sell off in secondary loans, however. And for par names, this softness typically meant no more than a half-point fall through the month, even if some lower-margin credits took a harder hit. Pandemic-exposed names — many of which are now quoted in the mid-90s — also dipped a little, sources add, though these tended to move more in line with newsflow. "This is a softness led by the weight of issuance rather than fears of an economic downturn so discounted credits have been more resilient, though they have sold off a bit," said one account. Another source agreed, adding that after more than €20 billion of issuance in March it is not surprising that managers churned their portfolios to make room for further primary issuance.

The shift in tone was more apparent in newly priced deals, which increasingly limped into secondary once they freed to trade, even after seemingly well-supported syndications. This dynamic saw most deals generally settle around reoffer, with some even drifting below this level in uninspired trading. Looking at Foncia Groupe, for example, the €1.275 billion term loan portion of the B/B2/B rated French real estate services group's €1.925 billion recap allocated at the tighter end of guidance at E+350 with a 0% floor offered at 99.5, after a smooth syndication that also delivered a loose set of documents.

The deal initially broke in a 99.625/100 market but failed to hold this level, despite talk of support from the leads, and moved below reoffer into a rough 99/99.5 market where it has largely settled since. Foncia is still relatively unusual and most other names have generally held around reoffer, but little of the new issuance is moving too far away in early trading. "Allocations have got fuller and there is little demand to top up on the break," said one account.

The recent performance of new deals in secondary stands in contrast to that seen in the first part of the year. Then, deals such as the €965 million term loan backing Carlyle's buyout of Flender GmbH raced out the blocks into secondary to move a point higher on the break. And, while not all deals had such a strong start, a half-point gain on the break was not unusual at all.

Modest scalebacks

But the market in January and February was benefiting from pent-up demand from weak loan volume in the closing months of 2020, and a strong end to the year for CLO issuance (note, the European CLO market is the predominant investor segment in leveraged loans). The weight of supply to hit the market in the first quarter has though shifted this demand equation, and means managers are under significantly less pressure to invest.

This too has impacted average scalebacks to primary allocations, which were routinely described as "savage" in the first month or so of the year and could run to 90% or even more of order sizes.

Sources now say scalebacks are considerably more modest, and accounts add that they have been fully (or close to fully) allocated on some recent deals. "Investors are receiving high allocations so there is not much buying on the break," said one trader. "No one wants to push up levels as they know they will only get taken out or repriced at par," he added.

This too has led to some grumbles that arrangers are playing a good game during syndication, which they are happy to let accounts assume is going better than the final allocation suggests. That said, accounts do inflate orders on deals they know are going well to protect their final allocations — though managers say arrangers are experienced enough to know the real depth of the market. "There is a finite investor base in loans and banks generally know the capacity of each manager," said one account. "For us the level of oversubscription in the book is quite opaque," he added.

Either way, after the year's tightening cycle there are signs this fatigue is starting to affect pricing. LCD data shows that average margins for single-B euro-denominated deals fell from E+437.5 in the third quarter of 2020 to E+379.7 by the close of the first quarter of this year. Yields, meanwhile, have fallen from a high of 4.94% in the second quarter of 2020 to 3.92% by the first quarter of 2021.

In terms of individual deals, MBCC provides a good illustration of this pricing trajectory since last summer. Lone Star carved the company out from BASF as Skyscraper Performance Solutions in a deal backed by an €810 million term loan B that priced at E+450 with a 0% floor offered at 98 in July 2020, before returning with an add-on that was eventually increased to €300 million and allocated at 99.5 in September. The entire deal — alongside a new dollar tranche to take-out a privately placed facility — was then repriced in March at E+350, offered at par.

Margins steady
Managers and arrangers agree that margins are now stabilising. "Pricing isn't as aggressive as it once was and we are starting to see some pushback from accounts," said one manager. "This was needed given the lacklustre performance of primary deals in secondary, especially on those seeing multiple pricing revisions."

Indeed, after four months during which the only price flexes seen during syndication were tighter, March finally saw some deals move the other way. LGC Ltd., for example, priced its cross-border dividend deal wide of talk to take the euro tranche to E+375 with a 0% floor offered at 99.75, from initial margin talk of E+325-350. LGC is a life-sciences and testing firm that has done well during the past year but it is still rated B/B3/B+, and even the best B3 credits have generally priced in an E+375-400 margin range over the past two months.

"The market showed how far terms can be pushed," said one manager. "Good deals will still go highly oversubscribed, but a B3 at E+325 does just not add value to your portfolio no matter what type of investor you are," he added.

LGC was not alone, and others including Belron SA have closed deals at higher margin levels than guided at launch. That said, the moves up are still outnumbered by the moves down (even if these are getting smaller). LCD data shows the average size of a margin cut from guidance fell to roughly 27 bps in March, from 40 bps and 41 bps in January and February respectively. "Managers no longer have to do every deal and we've seen some discipline on pricing through April," said one manager.

This does not mean that the year's pricing falls are about to be reversed any time soon, but rather that margins should stabilise at current levels that see a good B/B2 credit settle around E+350. Both arrangers and investors agree that the opportunity remains extremely strong for European loan borrowers, and a strong pipeline for buyout- and acquisition-related supply is set to keep the market busy into the second quarter and beyond.

The sheer weight of this supply may yet lead to more patches of secondary weakness, though accounts say sponsors and arrangers are more likely to give way on other terms before they concede ground on pricing. "Often pushback will see gains in areas such as margin ratchets or MFN clauses, while the headline margin stays the same," notes one manager.