The multi-billion dollar leveraged buyouts that will be hitting the markets the next few months may get some help from the new ratings methodology rolled out by Moody's Investors Service. With facility ratings expected to be about one notch higher on many names--changes will be applied to about 1,300 corporate issuers in North America--more banks may be willing to play in, and hold more of, deals they would normally shy away from.
"Banks' appetite for companies rated BB is far greater than their willingness [to take on paper] of those rated B," said Dan Toscano, managing director and head of senior debt capital markets in the Americas at Deutsche Bank. He said it may have to do with risk appetite as well as capital charges, but banks are definitely more comfortable doing BB credits. Some market players said the new methodology does not change the probability of default of a company or the corporate family rating, but it does change the facility rating and if banks just look at that rating, they could be more comfortable doing credits that were previously rated B.
Although ratings have not come out for the new billion dollar credits, Toscano said bank participation will "absolutely" help these deals get done. Many in the market have speculated that all investors, including banks, will have to participate and hold large chunks in order for these deals to clear the market.
Another effect collateralized loan obligation managers have been concerned about is pricing. With ratings going up, many have been concerned companies will take the improved facility rating as a reason to go to the market and ask for a reprice. Pricing may also be affected if banks do hold more in upgraded credits, which could lead to oversubscribed deals and lower pricing.
"I think that could really be the impact that could make the difference about whether you would see much in the way of companies being able to reprice, particularly with the single B credit going to a BB," said Jonathan Insull, managing director and portfolio manager at Trust Company of the West. "Credit spreads are a function of supply and demand and there is a lot of supply coming with HCA, Kinder Morgan and Aramark, as well as a lot of M&A activity. There is a lot of supply that should have the effect of pushing spreads wider, but on the other hand...that might bring in some marginal demand for loans, particularly from banks because they are more ratings sensitive."
The "bank effect" may put downward pressure on spreads, so that loans that potentially would clear at 250, may now be able to get done at 225 because the lead arranger will have more investors to go out to. "I think the factor that mitigates against [downward spread pressure] is the large deals that are coming," Insull said.
Moody's published its final methodology for loss-given-default assessments and probability-of-default ratings two weeks ago. The ratings agency will begin to roll out the new ratings this Wednesday by industry and all new deals will be rated with this new methodology at that time. The effective date for existing corporate speculative grade issuers in the U.S. and Canada is Sept. 18 (CIN, 8/28).
"I think it gets to the issue of balance between supply and demand for bank loan paper. The extent to which supply and demand balance swings between the pro rata and the institutional market is not something I am in a position to comment on," said Mike Rowan, Moody's group managing director and co-head of corporate finance in the Americas. "We're just trying to put out the best quality indicator that we can."
