New-Issue Spreads Narrow in November, but Terms Tighten as Mix Shifts to Corporate Loans
Loans rose modestly in November even as falling Treasury yields turbocharged interest-rate-sensitive assets. The Credit Suisse Leveraged Loan Index returned 1.19%, including interest accruals, during the month while the S&P 500 jumped 8.6% and the ICE BofA HY Master put a 4.55% gain on the board. In addition to improving investor sentiment across the capital markets, constructive technical conditions bolstered loan prices in November as visible demand exceeded supply by $12.4 billion, the seventh straight monthly surplus:
- Supply: $13.0 billion, including: (1) $12.3 billion of priced new-issue volume net of associated repayments and (2) $670 million of BWICs.
- Demand: $25.4 billion, comprising: (1) $10.8 billion of CLO issuance, (2) $13.5 billion of loan repayments not associated with new loans, (3) no OWICs, and, per Refinitiv Lipper, (4) $1.03 million of loan mutual fund outflows.
With the secondary firm and animal spirits on the rise, new-issue market metrics mostly trended toward borrowers in November:
- Secondary Prices: The average Credit Suisse Loan Index bid gained 0.40 point to 94.52 on Nov. 30 from 94.12 on Oct. 31. The average is now off 0.71 point from its YTD high of 95.23 on Sept. 19, but up 2.42 points from recent low of 92.10 on May 31.
- Par-plus Loans/Repricings: The share of Index loans bid at par or higher jumped to 14.5% on Nov. 30 from 5.0% a month earlier. Not coincidentally, mark-to-market repricing volume rebounded to $5.4 billion from $1.9 billion in October, though this was far below September’s 31-month high of $23.0 billion.
- Price Flex: Arrangers tightened 18 loans during syndication in November while widening five, or 3.6:1. That compares with a less
lopsided ratio of 2.5:1 in October. - New-issue Clearing Spreads: The average all-in clearing spread of single-B new issues narrowed to S+465 (S+423/98.7) in November—and to S+453 all-in (S+418/98.9) during the latter half of the month, reflecting improving conditions—from a six-month peak of S+521 (S+456/98.1) in October, but remains wide of September’s 19-month low mark of S+445 (S+409/98.9 OID). B3/B- loans were a heavier lift in November, clearing at an average of S+509 (S+456/98.4) compared to S+447 (S+409/98.9) for B1/B+ and B2/B rated loans.
- Covenant Flex: Covenant Review generated final Documentation Scores for 11 loans in November, three of which were PE-backed. Seven of the 11, or 64%, didn’t flex any of the terms tracked in Covenant Review’s scoring model, up from 44% in October.
- Covenant Terms: With the mix weighted to non-PE-backed loans, the average Documentation Score tightened to 3.43 in November on Covenant Review’s scale of 1 (most protective) to 5. That is on the more protective end of the recent range and compares with 3.56 in October. For PE-backed loans, a more consistent sample, the average score in November stood at 3.84, little changed from 3.86 in October and in the middle of the recent range.
The degree to which Documentation Scores moved on average between launch and close remained elevated in November at 0.16, just inside October’s 13-month high reading of 0.18. Among PE-backed loans, the flex gap jumped to a 14-month high of 0.48, as the few deals in play reached for aggressive terms from 0.24 in October (see the charts above). Given the limited number of loans in November’s sample, the three-month averages give a more data-rich view of the trend in covenant terms. On that basis, the average Documentation Score of all loans in Covenant Review’s score was effectively unchanged at 3.65 during the three months ended Nov. 30 (L3M), compared to 3.62 in the third quarter. For PE-driven loans, the average expanded to a 19-month wide of 3.93 in the L3M from 3.70.
Given the limited number of loans in November’s sample, the three-month averages give a more data-rich view of the trend in covenant terms. On that basis, the average Documentation Score of all loans in Covenant Review’s score was effectively unchanged at 3.65 during the three months ended Nov. 30 (L3M), compared to 3.62 in the third quarter. For PE-driven loans, the average expanded to a 19-month wide of 3.93 in the L3M from 3.70.
Outlook: Looking Up
Opportunistic volume staged a modest comeback after plunging in October, as the following chart illustrates.
During the final four days of the month, in fact, the market saw a flurry of such activity, with arrangers launching seven repricings and four extensions totaling $4.9 billion and $5.8 billion, respectively. That doesn’t include an additional $2.35 billion via (1) PG&E’s $750 million combination extension/repricing and (2) three additional deals— Summit Materials, Davis Standard and Surgery Partners—in which the borrowers in question cut spreads on a total of $1.6 billion of existing loans as part of broader financing executions.
Participants expect opportunistic loan volume to be the main focus of activity through year-end and into the first quarter as borrowers take advantage of constructive tone lower spreads and push out maturities—assuming the market is not rocked by any disruptive shocks.
Certainly, the supply side is lining up as a technical positive in the near term despite the fact that LFI’s gross forward calendar grew to $26.4 billion on Nov. 30 from $18 billion a month earlier. For one thing, net of associated and non-associated repayments, the calendar ended November at minus $1.6 billion, compared to minus $3 billion on Oct. 31. For another, capital formation is running hot. Loan mutual funds, as noted above, returned to the black in November to the tune of $1.03 billion per Refinitiv Lipper, amid improving investor sentiment. Moreover, repayments were robust again in November, climbing to a 24-month high of $13.5 billion, from $11.7 billion in October. November’s total was bolstered by $7.4 billion of private-credit-for-BSL takeouts—a trend that shows no sign of abating as highly leveraged borrowers that can no longer clear the ratings hurdle of the BSL market turn to private lenders to extend maturities or for growth capital.
HY-for-loan takeouts, meanwhile, were subdued in November at $700 million across two deals. That number, however, is on the incline. Already, LFI is tracking $2.2 billion of pending HY takeouts in the offing, and likely more if November’s muscular high-yield rally doesn’t lose steam in December.
Still, with a growing percentage of CLOs past their reinvestment period, the impact of repayments will be increasingly muted in the months and quarters ahead. That leaves new CLO creation as the primary source of new loan demand. In November, the CLO engine was purring. All told, managers inked $10.8 billion of new BSL vehicles, not including $4.8 billion of middle market deals. That is the most since February’s tally of $12.0 billion and at the high end of the historical range. Managers say that despite all the well-known headwinds facing the CLO market—lower but still wide liability spreads, tight arbitrage, the recent runup in better-rated collateral prices—production shows no sign of abating.
Looking ahead to the first quarter, players are, for the moment at at least, optimistic that M&A loan supply will bounce back after a deeply disappointing 2023. Through November, M&A-driven syndicated institutional loan volume totals $61 billion in the YTD. That is less than half of 2022’s full-year total of $141 billion and puts 2023 on pace to produce the lowest amount of such volume since LFI began tracking these stats in 2016.
Of course, we’ve been here before in recent years, with nascent hopes of growing supply dashed by events (e.g., Ukraine, SVB’s implosion, Middle East war), as well as market headwinds in the form of rising rates and a wide valuation gap between sellers and buyers. A myriad of geopolitical and economic risks continue to cloud the forecast. For that reason, players say, managers continue to be selective. There’s no reason to swing for the fences, after all, in the final inning of what’s already a strong year for the asset class along several dimensions:
- Total Return: The Credit Suisse Index total return in the YTD is 11.26%. If that is where things stand Dec. 31, it would be the second-best return for the Index behind only 2009 at 44%, when the market was recovering from the Great Financial Crisis and up from effectively zero (negative 0.01% to be precise) in 2022.
- Price Gain: The average bid of the Index is up 2.63 points in the YTD, its biggest annual increase since 2016.
- Default Rate: The lagging 12-month loan default rate rose only modestly to 3% at the end of November by volume from 1.6% at year-end, according to Fitch Ratings.
Broad Covenant Trends
Covenant Review’s benchmark three-month rolling stats were generally flat to a touch tighter in the L3M compared with third quarter levels.
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The highly negotiated terms we track here monthly were relatively stable in the L3M compared to third quarter levels.
The total average day-one basket capacity for restricted payments, debt issuance and investments into unrestricted subsidiaries were also mixed in the L3M compared to third quarter levels and remain below the peak levels of late 2021/early 2022.
Edgy Documents More Frequent in the L3M
The share of loans in Covenant Review’s sample that got over the goal line at the least protective end of the Documentation Score band (4-/5+/5) fell to 18% overall and 33% for PE-backed in November, from 38%/40% in October. Still, the percentage of edgy deals in the L3M increased from third quarter levels:
- PE-Backed Loans: The share in this category that cleared at the three least protective scores (4-, 5+ and 5) climbed to a nine-month high of 38% in the L3M, up from 21% in the third quarter.
- All: The share of all loans that cleared with a 4-/5+/5 perked up to a 12-month high of 27% in the L3M from 19% in the third quarter.
Incrementally Mixed
The average free-and-clear incremental tranche dollar-cap stood at 1.07x pro forma EBITDA in the L3M, even with the third quarter level. For M&A-driven loans, the average increased to 1.17x from 1.06x in the third quarter.
Looking at the distribution, the percentage of loans with F&C dollar caps set at 0.9x of pro forma EBITDA or more was 65% overall and 65% for M&A-driven loans in the L3M, compared with 68%/81% in the third quarter.
The share of loans with F&C grower components was little changed, at 84% overall and 96% for M&A-related loans in the L3M, compared with 84%/94% in the third quarter.
For those deals with growers, 1x EBITDA was the most common setting again in the L3M.
MFN Terms: Sideways
In November, five loans printed with an MFN sunset, per LFI reporting (the latest list is here), compared with three in October. That put the rolling-three-month count at 15, down from 20 in the third quarter.
The share of loans that cleared with an MFN sunset, meanwhile, ticked up to 36% in the L3M from a three-year low of 33% in the third quarter.
For the deals that cleared with an MFN sunset, the share with the least protective setting of six months increased to 31% in the L3M—including such November loans, per LFI, as Hilton Worldwide and IVC Evidensia—from 25% in the third quarter. On the other end of the spectrum, the share set at 24 months or more pushed to 18% from 13%.
The share of loans with more generous yield protection of 75 bps or more increased to 18.3% in the L3M from 12.0% in the third quarter.
The percentage of loans with various carve-outs to MFN protection was mixed in the L3M compared with the third quarter.
The share of outside maturity carve-outs set at a more aggressive one-year period increased to 64% in the L3M from 55% in the third quarter.
The frequency of inside maturity carve-outs was little changed at 48% in the L3M, from 46% in the third quarter. For those loans that did clear with an inside maturity, the average capacity narrowed to 0.64x of pro forma EBITDA from 0.70x.
Pick-Your-Poison: Uptick
The frequency of the Pick-Your-Poison feature—a term of art to describe a borrower’s ability to shift capacity originally permitted for restricted payments and convert it into capacity to issue debt and, in a growing number of cases, make investments in unrestricted subsidiaries—rose to 33.8% for all loans and 48.9% for PE-backed loans from 25.3%/32.7% in the third quarter.
J. Crew Trapdoor: Fewer
In the L3M, 2.3% of all loans and 4.8% of PE-backed loans in Covenant Review’s sample printed with the pass-through trapdoor loophole associated with J.Crew, compared with none in the third quarter.
Tranche Voting Rights (Serta): More Protections
The percentage of loans that required all affected lenders to approve amendments (see here for Covenant Review’s analysis of this issue) stood at a near-record 69.0% for all loans and 89.5% for PE-backed loans in the L3M, up from 66.0%/80.6% in the third quarter.
EBITDA Adjustment Definitions: Slightly Firmer
The percentage of loans in Covenant Review’s sample that allow uncapped adjustments to EBITDA inched to 38% in the L3M from 40% in the third quarter.
In the L3M, 14.0% of loans cleared with the most aggressive look-forward period setting of 36 months, just inside the third quarter’s read of 15.2%. On the other side of the spectrum, the share with a more restrictive 12-month setting declined to 8.8% from 13.0% in the third quarter.
Builder Basket Starter Amounts/RP Ratio Test Headroom
The stats in this category were a bit more generous in the L3M compared to third quarter levels.
The average degree of deleveraging necessary for issuers to meet restricted payment ratio tests expanded to 0.65x in the L3M from a multiyear low of 0.50x in the third quarter. The average closing leverage for these deals widened to 4.21x from 3.75x.
Asset Sale Sweep Step-downs
The percentage of deals with an asset sale sweep step-down ticked up to 43% in the L3M from 41% in the third quarter.
Excess Cash Flow Sweep
The share of loans with a more restrictive 75% sweep or more fell to 4.9% in the L3M from 10.4% in the third quarter.
Steve Miller
smiller@covenantreview.com
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