A rush of issuance in junk loans—driven by private equity firms seeking to improve the capital structures of their portfolio companies—was met with high demand from merger-and-acquisition (M&A)–starved investors, enabling borrowers to squeeze their interest margins by as much as 75 basis points (bps) on some offerings. But some investors are now feeling the strain. Managers of collateralized loan obligations (CLOs)—the biggest buyers of leveraged loans—are particularly struggling to make the numbers work.
“There is only so far pricing can move before it fails to make sense from an investor perspective,” said Sabrina Fox of Fox Legal Training, a leveraged-finance expert. The current dynamic between pricing and arbitrage shows the growing influence of CLO investors in the leveraged finance market, something that is likely to increase further, she added.
Resistance to spreads at such tight levels may lead to more discipline in the leveraged loan market, with more selectivity from investors as they reprice risk. Ultimately, that could reduce deal volumes, particularly as the traditional summer slowdown approaches.
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German medical labs business Synlab pulled a repricing deal for a €1 billion (US$1.2 billion) term loan, Bloomberg reported last Friday. While it wasn’t clear why the process was halted, some market participants say credit investors have so many options that fatigue has settled in and they’re getting more picky. Price talk for Synlab’s deal was considered aggressive at an initial 325 to 350 bps over Euribor, the people said.
Synlab’s pulled deal followed recent term loan B repricings by home care services firm Santé Cie and flooring company Gerflor, both of which ended up at 350 bps, the wide end of initial price discussions. While that’s still tight compared with historical spreads, it marks a change from a few weeks back, when loans offered by companies including Presidio Inc., ITP Aero, and Group.One managed to lower pricing to the tighter end of targeted levels.
Tight Spreads
The deal flood of recent weeks allowed some aggressive transactions to get through simply because investors didn’t have the time to assess them properly with a full investment committee, according to market participants who spoke on the condition of anonymity. However, investors are now starting to push back after the initial rush, and they’re getting more choosy as spreads hover near their lowest point in five years. Average spreads for Single-B–rated term loan Bs were at 393 bps on June 30—an uptick from the low of 359 bps seen before U.S. President Donald Trump’s tariff announcements in April, but still near the lowest since February 2020.
“You’re seeing performing credits trade at the tight end of historical ranges for different ratings cohorts,” said Brian Gelfand, co-head of global credit and head of credit trading at TCW Group Inc.
CLO managers are starting to resist investing in Single-B–rated deals at 325 bps over Euribor, according to bankers, as it’s difficult to make the math work for their model of repackaging loans to sell them on as bond-like instruments. These loan deals need to price at around 350 to 375 bps at least, at the moment, in order for CLOs to meet their running costs and pay their investors.
If investors continue to push back, companies will need to assess whether it’s worth launching these deals for a 25 bps reduction on their current loans, after taking into account the fees and work involved in repricing the debt, the market participants said.
The return of some caution is also showing up in the secondary market, at least in Europe. Average pricing on the closely watched Morningstar European Leveraged Loan Index has been drifting lower, hitting 97.61 percent of face value on July 4, from a high of 98.06 percent in June. In the United States, meanwhile, average secondary-market prices have reached a more-than-four-month high of 97.30 cents on the dollar.
To be sure, investors have a lot of cash to put to work or keep invested and the vast majority of deals are still succeeding, even if borrowers have to soften their initial pricing expectations. Companies are continuing to launch cross-border repricings as the summer approaches. Software firm Suse SA came to market today with a deal looking to achieve 350 bps on its euro term loan and 300 to 325 bps on the dollar tranche.
“We are, overall, in a very strong market. If you look at order books, the quantum of money coming into these trades is very large across the board,” said Fabian Ansorg, co-head of European Leveraged Finance Capital Markets at Bank of America. “There is some fatigue—it’s more work fatigue than deployment fatigue,” he said.
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