LPC: U.S. second-lien market could be primed to reopen to syndications

NEW YORK (Reuters) - Banks are considering underwriting second-lien deals again after the market virtually shut down in late 2015, creating a trend that has been described as BYOJ, or “bring your own junior debt” for sponsors.

Second-lien debt is considered riskier than first-lien leveraged loans as it is subordinate to the first-lien debt and was the first area of the loan market to feel the pain of the volatility. The return of second-lien debt to the syndicated market would help boost lagging fee earnings at banks and provide more opportunity for sponsor-backed mergers and acquisitions, bankers said.

“I think we’re in transition mode,” a senior banker said. “We’re probably at that pivotal point in the market where underwriting second-lien debt starts to become a reality again.”

Deutsche Bank is leading a three-year extension on a $200m second-lien loan for prepared foods company AdvancePierre Foods. The deal launched alongside a $1.1bn first-lien loan that will be used to refinance the company’s debt.

Bankers said this marks the beginning of a recovery as the loan market makes a sharp turnaround from the volatility that defined the last quarter of 2015 and the first quarter of 2016.

Banks are keen to see a return to underwriting second-lien debt after they generated US$1.28bn in underwriting fees last quarter, which was the lowest since the third quarter of 2011 and down 29% from the fourth quarter of 2015 and 7% from the first quarter of 2015.

LOSS OF BUSINESS

During the first quarter of 2016, issuers arranged just US$1bn of second-lien debt in the middle market, where most second-lien loans are placed, according to Thomson Reuters LPC data. While this is substantially below the US$1.3bn raised in the first three months of 2015, what is most striking is how the debt was placed.

Banks syndicated 42.5% of second-lien loans in the middle market during the first quarter of last year, but that number slumped to just 5.5% last quarter.

Bankers attributed this to the volatility that hit in the second half of 2015 due to concerns over low oil prices, the Chinese economy and US earnings.

“Things were so bad at the end of the year that it was hard to underwrite a high-yield bond, much less a second-lien debt,” the banker said.

Syndicated second-lien debt has traditionally sold mainly to CLO buyers or business development companies, but these types of lenders hesitated during the bout of volatility.

“There’s no natural buyer base,” a second banker said. “It tends to be first-lien guys stretching for more yield or bond guys looking to buy something different.”

As these buyers pulled back, banks needed such high flex terms in order to agree to underwrite second-lien debt that it no longer made sense for issuers to go the syndicated route.

Second-lien deals that did get done were done on the side, as sponsors have had to turn to relationships at the credit arms of private equity firms and hedge funds to negotiate private placements. The alternative lenders provided capital individually or as small club deals for larger sizes.

In a recent example, media intelligence company Cision signed a US$370m second-lien loan along this month through a private placement to finance its acquisition of press release distributor PR Newswire along with a US$1.1bn first-lien term loan.

BIG SHIFT

The market tone has shifted dramatically though, and increased demand from CLOs and loan fund investors has caused demand to outstrip supply in the loan market. This has caused secondary prices to creep up and banks to look to refinancing and repricing deals to get the market moving. It could open the door for second-lien syndication again, though the bond market, which has led the credit rebound, could be the first place issuers look.

“I think that while second-lien will continue to play a big roll, but the Triple C bond underwrite sounds like it could be coming back first,” the second banker said.

The first banker said that they recently received a pitch that they were able to run by investors that the sponsor had talked to previously about a potential private placement. The bank was convinced that there was enough interest from the lenders that it plans to offer to syndicate the deal.

“It might not technically be preplaced, but you have enough interest from investors that you’re comfortable that you’ll be able to find a market for it,” the banker said.

Gary Rosenbaum, a partner at McDermott Will & Emery LLP, said the ability to place second-lien debt bodes well for sponsor-backed activity in the future, as this is a crucial part of the capital structure when banks can’t underwrite first-lien debt without rankling regulators.

“The bottom line is you really need availability on the second-lien debt market,” Rosenbaum said. “We are seeing a pickup in activity. There are a lot of auctions percolating out there. If there’s a stable source of financing and second-lien debt comes back, then I think the fourth quarter could get active and interesting.”

(Reporting by Jonathan Schwarzberg; Editing By Michelle Sierra and Chris Mangham)