On the back of interest rate concerns, we have seen a massive interest in the floating rate loan space, with an astounding 91 consecutive weeks of inflows into loan exchange traded and mutual funds, and last week we saw among the largest inflow on record into the loan ETF space.¹  And with that massive demand for loans, we have seen a wave of refinancings and re-pricings, the latter meaning that none of the terms on the loan change other than the company seeking to pay the existing holders a lower coupon rate.  Below is a prime example of some of what we are currently seeing in the loan space.

We recently held a loan that was priced at a LIBOR floor of 1.25% with a spread of 600.  At this level of yield, we felt it was an attractive holding.  However, in February the company announced that they were going to refinance the existing loan with a new loan, and also pay a dividend to the private equity holders of $145mm.  So they came to market taking out the existing debt with a $520mm first lien term loan to replace the existing term loan, but the LIBOR floor dropped from 1.25% to 1%, and the spread dropped from L+600 to L+400.  Nothing had changed with the company, there was still the same amount of leverage through this level of debt, yet now they were paying their loan holders 2.25% LESS in interest.  And this given the fact that arguably the credit profile had worsened, with the company adding a $145mm second lien to the capital structure, which was used to fund the dividend to the private equity sponsors.

The loan market is in the midst of a massive repricing, and investors need to beware.  In our case, we saw the original loan as offering an attractive yield given the credit, but at 2.25% lower yield, we certainly were not interested.  However, the passive products just accept the lower yield and add it to their portfolio if the security becomes part of the underlying index; there is no credit work done to determine if this yield is appropriate for the credit risk of the company.  With the vast majority of the loan market trading above par, and very small call premiums relative to what we see in bond-land, we expect more of this.  Just last week alone, we saw 50% of the issuance volume related to repricings and primary loan activity in March is on track to surpass February’s issuance, which was the sixth highest monthly volume on record.²  Not to mention the fact that we have seen interest rates do nothing so far this year and LIBOR floors will constrain the “floating rate” benefit (see our recent writings on LIBOR floors and rates, “The Expanding Leveraged Loan Market:  Is It What It Seems?”), so investors are sacrificing lower yields relative to bonds.  While there are selective opportunities for attractive value in the loan space, and we have been able to take advantage of those in our vehicles, broadly speaking we see this market as over-valued and yields available not properly compensating investors.

1 Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li..  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research.  March 14, 2014, p. 4.

2 Acciavatti, Peter D., Tony Linares, Nelson Jantzen, CFA, Rahul Sharma, and Chuanxin Li..  “Credit Strategy Weekly Update.”  J.P. Morgan, North American High Yield and Leveraged Loan Research.  March 14, 2014, p. 7.