U.S. middle market investors wary of aggressive structures

NEW YORK (Reuters) - Middle market lenders and investors are wary of aggressive terms and loosening structures even as spreads on leveraged loans to U.S. middle market companies remain stable heading into the fourth quarter.

Given the middle market’s relative insulation from global volatility and broader market swings, price guidance on the latest crop of middle market loans is squarely in the 425bp-475bp over Libor range.

If investors are comfortable with where spreads are clearing, they are less keen about weakening terms and structures, which are a function of the highly competitive middle market landscape and modest dealflow.

While one investor said there is a fair amount of dealflow, he had expected to see more leveraged buyout activity by the end of September, and although the fourth quarter is expected to produce enough activity to keep investors busy, they will be paying particular attention to how deals are structured.

“Pricing is stable, flow is stable, and leverage is stable at a slightly higher level, but structures and terms will erode,” said the investor.

Another investor said borrowers and sponsors are looking to secure as much flexibility as possible – accordion features are fairly loose, providing the ability to re-up and re-lever through the accordion option. Likewise, covenant-lite deals are surfacing again in the middle market, which has typically been more disciplined on requiring covenants.

Jefferies is leading a pair of covenant-lite transactions – a deal for Novetta Solutions, as well as a US$425m covenant-lite credit backing IT systems performance monitoring company Idera Inc’s acquisition of Embarcadero Technologies.

After tumbling in 1Q15 to a meager US$630m compared to a whopping US$6.06bn in the year earlier period, middle market covenant-lite volume climbed to US$3.01bn in 2Q15 and stands at US$2.96bn so far in 3Q15, including completed deals and those in the pipeline, according to Thomson Reuters LPC data. By comparison, middle market covenant-lite volume was US$5.31bn in 2Q14 and US$4.31bn in 3Q14.

STABLE PRICING

Upward pressure on spreads stemming from wider volatility has been offset by the downward pressure created by both the continued supply-demand imbalance and the competitive dynamics that have characterized the middle market for so much of 2015.

“The market for traditional senior secured, first-lien middle market loans is solidly in the Libor plus 425-475 range,” said one middle market investor, noting that 425bp over Libor is pretty much the floor.

The average middle market first-lien term loan yield, assuming a three-year term to repayment, is 5.96% so far in September, up marginally from 5.85% in August but tighter than the 6.4% recorded in July.

By comparison, yields in the large corporate market increased more steeply as broader market volatility contributed to some caution from institutional loan buyers.

The average yield on first-lien large corporate term loans is at 5.55% so far in September, up from 5.11% in August. At these levels, the middle market premium has tightened to 41bp in September from 74bp in August.

AUTUMN CROP

The first-lien portion of Novetta’s covenant-lite US$325m acquisition credit facility is guided at 450bp over Libor with a 1% floor, offered at a 99 original issue discount. The second-lien tranche is guided at 850bp over Libor, also with a 1% floor and 99 discount. Proceeds fund the company’s sale to alternative asset manager The Carlyle Group from financial sponsor Arlington Capital. Jefferies and Societe Generale lead the deal.

Similarly, Universal Fiber Networks, a manufacturer of solution-dyed and natural synthetic fibers, is marketing a US$165m first-lien term loan B at 475-500bp over Libor with a 1% Libor floor and 99 issue price, while the US$40m second-lien term loan is guided at 850-875bp, with a 1 percent floor and 99 issue price. BNP is arranging the financing, which funds the company’s secondary buyout by H.I.G. Capital from Sterling Group.

Meanwhile, a US$510m dividend recapitalization loan for travel company Apple Leisure Group is also guided at 475-500bp for the US$330m first-lien term loan and 875-900bp for the US$130m second-lien term loan. The discounts are set at 99 and 98.5, respectively. The deal is led by Jefferies, along with Credit Suisse and Nomura.

(Editing By Chris Mangham and Jon Methven)