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After leveraged loan surge, risk/reward tilts toward investors

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After leveraged loan surge, risk/reward tilts toward investors

The second-quarter new-issue glut brought more balance to the risk/reward equation in the U.S. leveraged loan market, with investors seeing higher compensation on a risk-adjusted basis.

Looking specifically at leveraged-buyout loans for issuers with more than $50 million of EBITDA, spreads over the London Interbank Offered Rate widened, while pro forma debt/EBITDA ratios declined, in both cases to levels not seen since 2016, according to LCD.

As a result, loan investors in the second quarter saw 76 basis points of spread per turn of leverage on these deals, the most since the fourth quarter of 2016, up from 59 basis points in the first quarter and from a 69-basis-point average in 2017.

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On a yield-to-maturity basis, the increase was even more dramatic. Yield per unit of leverage rose to 126 basis points in the second quarter, a six-year high, from 95 basis points in the first quarter and a 94-basis-point average in 2017. This jump in yield is entirely a result of the increase in spreads, as the base rate for these loans — 90-day LIBOR, for this analysis — ended the second quarter about where it started, at 2.34%.

This rebalancing of risk and reward, in favor of investors, stands to reason.

Over the course of May and June, about $25 billion of buyout-related loans launched into syndication, the highest two-month tally since 2007. In fact, LBO issuance has exceeded $20 billion during a two-month period only one other time in the last year and a half, in August-September 2017, at $21.8 billion. Given such a sharp increase in supply, investors were able to push back on terms and pricing. As a result, 11 of the 13 buyout loans launched in June were flexed higher during syndication.

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In the second quarter overall, LIBOR spreads on buyout-related institutional loans launched to syndication rose to 413 basis points above LIBOR, or L+413, the highest since the fourth quarter of 2016. That is up from L+347 in the first quarter and from an L+394 average in 2017. This is news. The cost of capital for a leveraged-buyout loan has largely been on the decline over the last two years, as measured by the spread on first-lien term loans. The second quarter's 66-basis-point jump is the highest quarter-on-quarter increase since the fourth quarter of 2014, from L+405 to L+480.

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At the same time, the average pro forma debt/EBITDA ratio of large corporate leveraged buyouts fell to 5.4x in the second quarter, the lowest reading since the third quarter of 2016, down from 5.8x during the first three months this year (that was the quarterly average in 2017, as well). Leverage through the first-lien term debt retreated to 4.3x over the past three months, roughly on par with levels seen in 2016 and down from 4.6x in the first quarter and the fourth-quarter of 2017, which was a post-crisis high.

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As a result, the share of buyouts with a 6x debt/EBITDA ratio fell to 42% in the second quarter, down from near or above 50% in each of the previous four quarters. The 42% number is the lowest reading since the third quarter of 2016.

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LCD News is an offering of S&P Global Market Intelligence.