Outlook 2019: Leveraged loan issuance anticipated to decline; M&A, CLO support eyed

By Sara Rosenberg

New York, Dec. 31 – Total primary loan issuance is expected to be lower in 2019 when compared to 2018, with somewhat lackluster investor demand for opportunistic transactions, according to market sources.

A sellside source expects that issuance will probably be lower for most of 2019 but will pick up in the second half of the year.

“Opportunistic and repricings will most likely be lower. At the moment, the technicals are not supporting it. If a credit truly performs, it’s up for repricing, but with CLO liabilities widening and spreads already cut, I don’t know if we’ll see as a large of a repricing wave based on more demand than supply. Continue to be a ton of [private equity] money so will continue to see LBOs/M&A transactions,” the sellside source added.

“I think a cooling market is most likely by year-end 2019, so less issuance than in 2018 as refi pressure abates and opportunistic dividends become less palatable. Cooler market also means less M&A and LBO activity,” a market source remarked.

A buyside source agreed that issuance in 2019 will probably be down, maybe just slightly, from issuance in 2018.

Another source said there should be a decent flow of issuance in the first part of 2019 as deals were being pushed from late 2018 business into 2019 due to an unfavorable market.

The source went on to say that the M&A world is active and private equity has a trove of cash available so that will drive volume in 2019. He expects volume to be similar to 2018 on a net basis.

He also explained that if the CLO market remains stable, the new issue market will have stable demand.

The source remarked that the expectation is for recent outflows in loan funds to abate and stabilize in 2019. He said that the market environment shifted in the latter part of 2018 with a change in sentiment and technicals, creating a storm. As a result, people were repricing that risk. However, once that risk is repriced into senior loans, the market will stabilize and be fine.

Another possibility is that there might be some growth in the pro rata market if pressure continues in the secondary market on the term loan B side, the source added.

Second-liens flat to down

Second-lien loan issuance is expected to be unchanged to lower in 2019 compared to 2018, with the amount of privately placed transactions possibly rising.

“There may be the same amount of second-liens given [the] state of the high-yield market. If high yield improves, I would expect to see more unsecured bonds in lieu of second-liens. I expect second-liens to continue to be privately placed at [the] same or higher level than 2018. Sponsors have continued to grow their direct relationships and there is only more money at these credit funds that need to play direct deals for larger allocations,” the sellside source said.

“Second-liens are most interesting to hedge funds and aggressive managers betting on risk-on, and a cooling economy in 2019 will not be very supportive of such demand. Second-liens will remain a good alternative to high-yield bonds for smaller sponsored deals, but they will require a bit more coupon next year. That will make private placements a bit more common, especially to friends of the sponsor.

“I think the shift reflects both need for yield at aggressive accounts and execution cost in the syndicated market,” the market source remarked.

“We saw quite a few second-liens we would have bought in the primary in 2018 that were privately placed. Good structures work for patient capital even in tough markets,” the market source added.

The buyside source said that he expects second-lien issuance to remain the same or be down in 2019 versus 2018.

Covenants may change

Some sources are expecting more covenants to appear in loan transactions in 2019 versus 2018, and some are more focused on better provisions regarding various baskets and other documentation items.

“Covenant quality always reflects supply and demand. If the market cools with the economy, covenants will not get tighter, but it may take a bigger downturn to make them clearly better,” the market source said.

“Not offensive is more likely than good covenants in 2019, I think covenant-light, as traditionally defined, is not offensive,” the market source continued.

“Offensive covenants are J. Crew unrestricted subsidiary dividends and restricted payments buckets that can happen even in default, plus portable capital structures. Covenant-light will remain in a merely cool market. I do not know about MFN, but baskets and exclusions should get reined in,” the market source added.

As for the sellside source, he expects “more covenants for deals that are looked at as being in cyclical sectors.” In general, the covenants he expects to see are those related to leverage and maybe fixed charge coverage ratios.

The buyside source said that he anticipates seeing more covenants in loan transactions.

Another source remarked that covenant-light deals are probably here to stay but other terms, such as incremental and baskets will likely tighten in 2019.

Mutual fund liquidity

The buyside source noted that new Securities and Exchange Commission rules on mutual fund liquidity may be topical in 2019 “as managers approach that issue in a variety of ways.”

“The spotlight will be on sources of liquidity in loan mutual funds, including cash and lines of credit, as well as bonds,” he added.

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