In October Pret A Manger refinanced and borrowed more than £500m from investors. Months later, the UK coffee and sandwich chain had lenders back at the table, negotiating a deal that cut its loan cost.
The company is one of hundreds taking advantage of a relative dearth of supply of new loans and the appetite of money managers — who ultimately buy the loans — for an investment that will benefit from a backdrop of rising US interest rates.
“What’s happening in most of the repricing in the last six to 12 months is that investors have been desperate to hang on to the assets they have, so are generally willing to accept the lower margin paper,” says Chris Munro, co-head of Emea leveraged finance at Bank of America Merrill Lynch.
Since May, companies have cut their costs on more than $510bn of loans in the US and Europe, a record pace, according to data from S&P Global unit LCD. With the trend forecast to accelerate over the rest of the year, it is also raising concern that private equity companies — the chief issuers of the loans when they execute buyouts — risk straining their longstanding relationships with lenders.
“You don’t want to disappoint your lenders too much,” says a partner at a large buyout group. “It’s a question of having a relationship because they will have to be there in the tougher times when it’s harder to raise money.
“Doing it once when there is a clear big gap between what you initially priced the deal and where the market is. I think that’s reasonable. If you try to do it in smaller increments, you could have somebody feel bad about it.”
Investors holding loans also face a difficult decision when borrowers seek better terms. They are given the option to refinance the loan at less attractive terms or be paid out at 100 cents on the dollar, as they relinquish their spot to another investor. Given loans often trade above par before a refinancing, it means those investors who turn down the deal suffer a loss.
Eschewing the new tougher terms also forces them to search for other loans to plug the holes in their portfolios at a time when there is little sign of supply picking up. Leveraged buyout activity has rebounded from a slow start in 2016, but it remains below pre-crisis levels. Loans issued to fund mergers and acquisitions fell 39 per cent in the first quarter from the final three months of 2016, data from LPC shows.
A sustainable rise in new loan volumes “must come from mergers and acquisitions”, says Kevin Foley, head of JPMorgan’s high-yield business in Europe, the Middle East and Africa. “You could have a pick-up in dividend recapitalisations, but that is not enough to move the needle. Even some of the LBO activity has been from existing issuers.”
That is a view echoed by Beth MacLean, a bank loan portfolio manager with Pimco, who expects M&A to remain subdued until there is clarity on Donald Trump’s economic and tax policies.
“You have a lot of people waiting on the sidelines to see if they’ll get aggressive on M&A and how companies will be affected by changes on the tax code,” she says.
What’s more, the expiry of call protection, which forces companies to pay a fee if they wish to refinance their loans before a certain date, is likely to quicken the trend towards repricings. Loans in the US of a further $300bn could be cut over the remainder of the second and third quarters for this reason, portfolio managers at Newfleet Asset Management estimate. That would represent roughly a third of the overall US market.
Roberto Biondi, global head of the financing group at Permira, a London-based buyout firm, puts the acceleration in repricings down to the current dynamic between supply and demand.
“Prices and terms are more favourable for borrowers today. And private firms are taking advantage of it, lowering borrowing costs for the portfolio companies and allowing them to invest further in growth,” Mr Biondi says.
A €637m loan from Coherent, a laser company, for example, was repriced from 3.5 per cent to 2.25 per cent over Euribor. The loan was initially priced last August to finance the company’s takeover of Rofin-Sinar Technologies, and then was repriced this month.
And for now the upper hand is expected to stay with the borrowers. More than $30bn has flowed into loan funds around the globe over the past year, according to EPFR.
“There has been a hunt for yield in an environment where rates are rising,” says Kenneth Kencel, the chief executive of Churchill Asset Management LLC. “When investors put cash into traditional mutual funds . . . those investors expect that cash to be put to work.”