Spreads on institutional term loans are dropping to the lowest levels since the second quarter of 2000 even below pro rata pricing and the tightening is becoming uncomfortable for some institutional buyers. Raging demand in the "B" loan market and a continued lack of appetite for pro rata paper has spreads converging on deals such as the one led by CIBC World Markets and Bear Stearns backing Willis Stein & Partners purchase of Roundy's. The credit offers LIBOR plus 3% and LIBOR plus 31/ 4% for the prospective "B" and pro rata, respectively, said one banker. J.P. Morgan and Morgan Stanley last week cut pricing on the heavily oversubscribed $350 million "B" loan for Seagate Technologies 1/2% to a skinny LIBOR plus 2%--the same as the $150 million pro rata.
The spread compression on "B' tranches is leading to some concerns from investors that loans will become uneconomic for collateralized loan obligations and prime-rate funds. "Both CLOs and bank loan mutual funds, important drivers in the loan market, need a certain spread level to make the arbitrage work," said Jonathan Trutter, a managing director at Deerfield Capital Management. He noted that the pressure on spreads will ease as demand falls away, but that may not happen for another few months.
A banker cited Riverwood Holdings, Right Management and Ventas as other deals where pricing has converged. Ventas' $290 million revolver priced at 23/ 4% over LIBOR and a $60 million five-year term loan priced at 21/ 2% over LIBOR. Importantly the loans are often being sold at par with no upfront fee, said another banker, who said the supply and demand imbalance is forcing the spreads on the "B" down. The high-yield bond market and a shortage of new issue are fueling the imbalance, he added.
One buysider said, "There is too much money out there and amendments are cutting the spreads, but there are still pockets to play." Credits for Columbia House and Herbalife are said to be offering pricing north of 4% over LIBOR and Calpine offers 33/ 4% over, he stated. "Times can change and pricing is not going to the return to the levels of the early 1990s when every LBO was 21/ 2%," he noted.
But what of the pro rata? One banker argued that logically the pro rata should price above the "B" because it is often uneconomic. However, he does not see this as the long-desired price correction, nor does he see it as a precursor to one. "The 'B' is artificially low, and will rise again," he suggests. If this was a pricing correction then the undrawn fee on the revolver would rise, but it has not, he explained. The beneficiaries of the cheap pricing are the companies, that are cashing in through refinancing, but the losers are often the investors ploughing in on the deals (LMW, 4/8). An official for Seagate, confirmed the pricing and said "it is unexpected, but is due to the compression in the spreads."