Outlook 2017: Leveraged loan issuance expected to rise as strong technicals predicted

By Sara Rosenberg

New York, Dec. 30 – Total primary loan issuance is anticipated to rise in 2017 when compared to 2016 as demand is expected to be strong, the economy may improve and defaults are likely to remain low, according to market sources.

“We expect issuance to be slightly up for 2017 since the first half of 2016 was dragged lower with the overall market malaise that plagued the beginning of 2016. The ‘Trump rally’ that is most obvious in the equity markets has permeated over to the leveraged loan market as fund flows for floating-rate assets have picked up. We expect this demand to help drive issuance,” a sellside source said.

“In addition, the perception post-election is that the economy will be fueled by a fiscal stimulus driving output. The belief that there will be an expanding economy is an overall positive for leveraged issuers, which should help drive issuance as well,” the sellside source continued.

Another market source theorized that new money issuance in 2017 will probably be up from 2016, driven by an improving mergers and acquisitions outlook, although he expects refinancings to be somewhat flat on a year-over-year basis since there has been so much price compression already.

“We are seeing high 4B’s being done at 225 [basis points],” the source said of the spread on new loans.

A buyside source agreed that technicals point to a strong year of issuance in the leveraged loan market in 2017.

“Rising rates should spur retail demand (already started); low global rates should spur international demand – 2016 saw a lot of foreign money coming to the loan market and I expect that to continue – and Trump’s win may ease the Dodd-Frank overhang on CLOs to some extent, though that had already been resolved to a significant extent by new legal structures in 2016. Thus the technical backdrop for 2017 demand, and therefore supply, is good,” a buyside source remarked.

“The fundamental backdrop is also reasonable. Low maturities and slow growth should mean default rates remain low. While earnings look flat and bumpy in 2017 to me, that’s not very meaningful for loans compared to bonds or equities,” the buyside source continued.

It’s unclear whether issuance will increase in all types of deals, “but if the stock market stays high we’ll see fewer LBOs and more dividends. Lots of repricings,” the buyside source added.

Second liens flat to up

Some sources are anticipating that the total amount of second-lien issuance in 2017 versus 2016 will not see much of a change, but others are projecting an increase.

“Second-lien issuance will probably trend neither up nor down. It’s a useful option for small companies that cannot tap the high-yield market for that part of their capital structure, and it works to some extent for mutual funds and CLOs, but there is not broad demand for second liens, and that will keep issuance restrained,” the buyside source said.

The sellside source, on the other hand, expects second-lien issuance to pick up in 2017 versus 2016. He explained that the first part of 2016 saw an absence in the second-lien market because of choppiness of the global markets, which led privately placed, direct lenders to step into the second-lien market largely for 2016.

“While we have seen a resurgence of second-lien term loans as 2016 closes out, there still is some trepidation on the asset class due to the nature of the risk and to liquidity concerns, but overall we expect second-liens to continue to benefit from positive trends the leveraged loan market is ending on for 2016 and second liens to benefit as a result,” the sellside source added.

And, the other market source said that he expects second-lien issuance to be up on a year-over-year basis for the same reason as new money issuance, “improved M&A outlook.”

Covenant-light to remain

Sources are expecting little change in covenants in 2017 from 2016, with covenant-light transactions continuing to dominate the marketplace.

“Covenants will reflect supply and demand, and since I expect demand to be good I expect covenants to continue to be on the weak side of ideal. Still, good credits don’t need strong covenants to be good investments,” the buyside source remarked.

“I think the implications of weak covenants will be most evident on weak credits when the default cycle picks up, which might not be for two or three years.”

“Cov-light is 100% a function of supply and demand for loans, so since I expect good demand I expect mostly cov-light,” he added.

The market source said that he expects covenants to remain the same in 2017 compared to 2016, with the biggest focus being on EBITDA definitions and the level of add-backs.

“We expect issuance to be slightly up for 2017 since the first half of 2016 was dragged lower with the overall market malaise that plagued the beginning of 2016.” – A sellside source

“The technical backdrop for 2017 demand, and therefore supply, is good.” – A buyside source

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