It doesn’t really take a report to tell us that debt investors are facing the second half of the year “dazed and confused.” But anyway, that’s the conclusion from S&P’s Leveraged Commentary & Data, reports the FT.
The uncertain tone follows a turn in credit conditions that has seen a string of relatively aggressive financing deals, mostly for LBOs, postponed or sweetened in recent weeks.
The latest, a $1.15bn junk bond issue for ServiceMaster, a US lawncare and cleaning group, was pulled on Tuesday, the eve of America’s July 4 holiday.
It was a boom first-half. S&P reports that the global volume of junk-rated loans in the first six monhs of 2007 reached $545bn, up a staggering 62 per cent from the 2006 first half.
However, the recent shift in sentiment raises questions about the second-half outlook, with the most highly leveraged and aggressively structured deals clearly struggling to find buyers.
In another sign of investor nervousness, the difference between the yield on junk bonds compared with US Treasuries has risen recently, notes the WSJ. On Tuesday, the spread was just off its high for the year at 2.99 percentage points.
In the leveraged loan market, investors are resisting, in particular, “covenant-lite” loans that allow borrowers more flexibility than traditional loans and “payment-in-kind” or Pik bonds in which borrowers can pay interest in the form of new bonds rather than cash.
“Pik debt arguably is the hottest of the hot-money trends,” said S&P LCD in its Q2 review. “Thus, it has met the cruellest fate in recent weeks, as the market has cooled.”
At least four deals had pik components reduced or cancelled in recent weeks, namely Thomson Learning, ServiceMaster, Dollar General and US Foodservice.
In ServiceMaster’s case, the bond financing was initially slated to price last week with a pik structure, but was postponed and adjusted so that the pik accounted for only half the deal – and was then postponed again, on Tuesday, says the FT.
The company has also had to increase the interest rate on loans being offered to investors as part of a package to finance a $5bn LBO by a consortium led by Clayton, Dubilier & Rice. Bob Lee, credit analyst at KDP Advisors, a high-yield research group, said ServiceMaster’s financing had suffered from a combination of factors. “There was a little bit of [investors] stepping back from risk and a large number of deals – all mid-sized – and all highly leveraged,” he said.
According to S&P, however, both pik bonds and cov-lite loans featured strongly in the record-breaking first half for issuance.
Almost 35 per cent, or $104bn, of US loans sold to non-bank investors lacked traditional covenant protections, almost seven times the volume in the same period last year. Meanwhile, pik features appeared in $12bn of bonds and loans in the 2007 first half, up from less than $1bn.
The fate of cov-lite and pik structures is unclear, as is investor appetite for the most highly-leveraged deals. One factor allowing buyers to become more discerning is the huge supply of big deals on the way to the market, a “monster pipeline”, as FT Alphaville noted. As of last week, S&P LCD reckons a record $215bn of US non-bank loans were in the pipeline, compared with $120bn-$140bn earlier in the year.