Issuance in the U.S. leveraged loan market rebounded in the third quarter, as stabilizing conditions and increasing investor demand have drawn borrowers off the sidelines. Volume of institutional loans — the kind of loans bought by collateralized loan obligations and retail loan funds — rose to $71 billion in the third quarter, from a four-year low of $44.5 billion in the second quarter, a period stunted by volatility and uncertainty surrounding the growing pandemic.
Even with the quarter-over-quarter lift, total issuance remains well below what has been the norm, due to a snarled M&A market. Year-to-date institutional volume, at $204 billion through Sept. 29, is at a 10-year low, and is down 14% compared to the comparable period in 2019, according to LCD. Total M&A volume is down 25% from the year-ago period.
As acquisition-related financing has waned, opportunistic loan issuance has taken up some of the slack. Deals supporting refinancing of debt or funding dividends — mostly to private equity owners of the borrowing entity — has accounted for 46% of total issuance in the third quarter, whereas the 42% M&A share was the lowest since Q4'19. In the last three years, the average M&A share stood at 55%. The volume of dividend recapitalizations ballooned to $13 billion during the third quarter, the most since Q2'18. The 18% dividend share of total issuance in the third quarter was the highest since Q4'16.
As with other risk asset classes, the loan market staged a recovery after the pandemic-induced cratering in the second quarter, and by September the market had righted itself to the point that the total return of the S&P/LSTA Leveraged Loan Index for 2020 briefly turned positive. As the secondary market embarked on its prolonged rally, new-issue activity came in fits and starts. The second quarter ended with a thrust of pent-up M&A financing, but once that cleared the loan syndications market, new issuance was relatively quiet through the summer months.
That changed in September as acquisition-related activity gained traction. September’s $16.4 billion of such activity was the most since January and accounts for 56% of M&A supply in the third quarter. But it was late arriving. In fact, 70% of September’s M&A volume only launched to market in the second half of the month. That includes some large LBOs to fortify the total: a $2.335 billion institutional loan to finance the acquisition of HD Supply Holdings Inc.'s construction and industrials business by Clayton Dubilier & Rice, and $1.745 billion of first-lien and second-lien term loans for Infoblox Inc.
Before this M&A wave washed over the market, issuers were tapping into investor demand to address upcoming maturities or to return capital to shareholders. As evidence of the supportive market tone, price flex activity — in which pricing on a loan is changed during syndication depending on investor demand — was significantly skewed in the favor of issuers during this period. Third-quarter downward flexes, favoring borrowers, outnumbered upward flexes 17-to-1, a sharp spike from 6.3-to-1 in the second quarter and 4.7-to-1 in the first quarter.
With that, new-issue pricing descended from the stratospheric levels amid the risk-off mood in the second quarter. The average spread over Libor on new institutional loans from issuers rated B+/B fell to L+388 bps at quarter-end, the lowest since February, according to LCD. The all-in spread, which includes upfront fees and any Libor floor benefit, dropped 112 bps from the second quarter, to 487 bps.
Moreover, the loan market was increasingly receptive to riskier borrowers, as single-B issuance more than doubled in the quarter, to $51.1 billion, or 72% of total issuance, compared to 49% in the second quarter.
On the demand side, CLO issuance has been healthy in the quarter, at $23 billion through Sept. 28, and the market is expected to remain busy in the months ahead due to lower liability costs and to preempt potential volatility around the U.S. elections. Loan investors also saw roughly $38 billion of repayments during the quarter. Cash flows at retail loan funds were slightly negative by contrast. Although outflows from loan mutual funds and ETFs persisted over the summer — totaling $2.2 billion for the quarter through Sept. 22, according to Lipper — they were nowhere near the mass exodus in March.
Overall M&A issuance surpassed the second quarter but still lagged pre-pandemic levels, and LBOs, in particular, are running 38% lower from the comparable period of 2019. Buyouts, combined with other private equity-backed acquisition financing, did edge up slightly from the second quarter, to $18.9 billion, but overall was well below recent quarterly averages. For example, average quarterly issuance over 2018 and 2019 was $41.4 billion. The combined total for the second and third quarters of 2020 is the lowest for two consecutive quarters since the first and second quarters of 2012.
But financial sponsors were not standing idle in the debt markets, as opportunistic deals, as opposed to those backing acquisitions, rose to their highest level since Q2'18, at $19.3 billion, accounting for 49% of total sponsored volume, the highest share since Q4'16. Of all the sponsor-backed issuance in the third quarter, 27% has supported dividend recaps, the most since Q4'16. This included benchmark-sized deals for Radiate Holdco LLC, at $2.69 billion; Epicor Software, at $1.925 billion; and Ellucian, at $1.6 billion.
Overall dividend recap volume from sponsored and non-sponsored issuers was $13 billion in the third quarter, the most since Q2'18, which saw $14.5 billion.