Reuters LPC: Alternative Lenders Gain Ground As Investors Support Aggressive Deals

Feb 10 2017 | 11:17pm ET

By Jonathan Schwarzberg (Reuters LPC) - Red-hot investor demand for U.S. leveraged loans is helping institutions not bound by federal lending guidelines to lead and sell aggressive deals that traditional arranging banks are unable to provide.

Deals that could have drawn regulators’ ire if arranged by traditional banks, including a $1.375 billion repricing for mixed martial arts franchise Ultimate Fighting Championship (UFC), which was originally criticized for accounting adjustments, and a highly leveraged $1.6 billion repricing for Tibco Software, sailed through the market when led by KKR and Jefferies, respectively.

Demand is strongly exceeding a limited supply of new deals in the U.S. market as cash continues to pour into the asset class. Investors are doing their own credit work and often feel comfortable buying transactions that may have been criticized by regulators seeking to limit risk in the banking system.

“We are not subject to leverage lending guidelines at this point, and we’re not criticized like a bank would be. It lets us do our own credit work, which I think is a good thing. We don’t have to rely on the regulators to tell us if it’s a good or bad loan. I don’t think we have ever turned down a deal because we didn’t think it would pass,” said Lauren Basmadjian, portfolio manager at Octagon Credit, which invests in leveraged loans.

The Federal Reserve, the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency released updated leveraged lending guidance in 2013 to curtail aggressive lending. Some lenders, such as KKR and Jefferies, are not subject to the guidance and are stepping up their profile as loan arrangers.

The repricing of UFC’s $1.375 billion term loan gave KKR a chance to step up and lead a deal that was criticized by regulators last year due to aggressive EBITDA add-backs, which allow companies to use future estimates of growth to increase cash flow, which lowers adjusted leverage levels.  

Goldman Sachs led the original UFC deal in August 2016 and seven banks agreed to arrange the debt for the company’s buyout by Silver Lake Partners and KKR-backed talent agency WME-IMG.

KKR, which acted as an equity investor in the initial deal, took over as sole lead arranger on the repricing from the original banks as part of its efforts to boost its underwriting profile.  

“When it comes to arranging debt financing, we focus on companies with attractive credit profiles that the institutional debt markets will support. Some situations are subject to limitations under the guidelines while many others are not,” Cade Thompson, head of U.S. debt capital markets at KKR Capital Markets, said.

UFC’s repricing was well received by investors, which allowed the company to obtain substantial cost savings by cutting pricing by 75 basis points to 325 basis points over Libor only six months after the original deal was issued.

“KKR has been able to carve out a really nice niche for itself in some of these deals and been doing a good job picking and choosing spots where the traditional banks are pulling back,” said Michael Terwilliger, a global portfolio manager at investment firm Resource America.

Highly leveraged Tibco Software was also able to make significant savings as it switched to Jefferies, which is not subject to lending guidelines, to lead its $1.6 billion repricing. The original deal ran into difficulties over its higher leveraged levels in 2014 amid market volatility, and underwriters were forced to sell it at a discount of 95 cents on the dollar as investors pushed back against the high leverage.

Jefferies successfully completed the repricing in January and cut the spread by 100 basis points to 450 basis points over Libor from 550 basis points over Libor despite leverage of 7.5 times, which is significantly lower than the 11 times in 2014, according to Moody’s, but exceeds regulators’ hurdle of 6 times, which is one of the measures that regulators use to determine whether deals need more scrutiny. The loan was originally led jointly by JP Morgan, Jefferies and others.

The growing role of non-traditional lenders as arrangers of leveraged loans is helping to push average leverage ratios higher. Leverage has increased to 6.5 times in 2017 so far, which is the highest level since 2014, according to Thomson Reuters LPC data.

SOME RESTRAINT

Although investor demand shows no sign of slowing as strong loan inflows continue, loan buyers are still showing some discipline around deals with low pricing levels and are prepared to push for improved terms.

Nutritional supplement maker Herbalife had to increase pricing to 550 basis points over Libor from initial guidance of 375 basis points over Libor to place a loan that was then increased to $1.3 billion from $1.175 billion after investors flocked in at the higher pricing point. The company will use the loan to refinance its revolving credit facility and put cash on its balance sheet.

B1-rated construction products company ABC Supply was forced to postpone a repricing deal on February 7 after investors failed to support a 50 basis points pricing cut to only 225 basis points from 275 basis points on a $1.875 billion term loan, which pushed repricing limits, sources said.


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