Jan 15 Leveraged loan pricing is rising in the U.S. as the first big deals of the year including a $2.525 billion buyout loan for retailer Petco Animal Supplies Holdings edge out into a turbulent market. Falling oil prices are dragging equities lower and complicating efforts by embattled banks to sell a multibillion dollar overhang of loans that were delayed from last year. Petco, which is rated B1/B, was chosen to reopen the market and establish a new pricing benchmark due to its strong financials, but pricing on the deal was increased last week and a new $700 million tranche was added with no Libor floor to boost returns for Collateralized Loan Obligation (CLO) funds after the deal received pushback from investors. Pricing on Petco's loan was increased by 25 basis points to 475 basis points over Libor with a 1 percent Libor floor. The no-floor tranche was added to protect returns for CLO investors against high Libor rates and will earn 500 basis points for investors. Petco's pricing is 75 basis points higher than the 400 basis points which competitor PetSmart paid last February on a $4.3 billion loan that backed its buyout by BC Partners. PetSmart later cut the price of the loan to 325 basis points over Libor from 400 basis points in May."Both the loan and bond markets have reasonably decent technicals right now, but the Single B part of the market is really where we are going to see how far things have steepened for new issue," said AJ Murphy, head of Global Leveraged Finance at Bank of America Merrill Lynch.
Investors are demanding higher pricing to compensate for higher risk and illiquidity in highly volatile markets and are focusing intently on selecting strong credits as their best defense against a possible downturn, which is driving market bifurcation. Software company SolarWinds, which also has a B1/B rating, launched a $1.5 billion buyout loan last week that was also held over from last year. The dual-currency loan, which is also rated B1/B, has higher pricing guidance of 500 basis points to 525 basis points over Libor and Euribor with a 1 percent floor and is also being sold in Europe. OVERHANG DILEMMABillions of dollars of U.S. leveraged loans including SolarWinds were put on hold late last year after a $3.3 billion cross-border loan for Veritas was pulled in November due to tough market conditions even after the company widened pricing to 500 basis points over Libor with a 1 percent floor and widened the discount to 95. A $1.35 billion term loan supporting Kraton Polymers' acquisition of Arizona Chemicals and a $575 million credit facility financing OM Group's buyout were also postponed.
Deals for companies that were perceived to be weaker credits, including a $1.5 billion buyout loan for department store Belk were forced to price at steep discounts as average secondary bids plunged. The SMi 100 index of the most actively-traded leveraged loans hit a low of 96.46 on December 18. The index, which is currently trading at 96.56, was trading at par last April. Market conditions have not improved significantly so far this year and persistently low secondary prices and negative macroeconomic developments since the start of the year are making it difficult for banks to underwrite new deals and harder for private equity firms to model pricing and have confidence that committed financing is available.
"The sponsors are not bringing deals right now and seem hesitant until they have a better feel for the market," an investment banker said. Petco and SolarWinds are expected to establish pricing benchmarks and the levels that they set will determine if more of last year's overhanging deals return to the market. Both deals will need to price and trade well for that to happen."If there's an LBO you're going to launch, it's going to be Petco," a second banker said. "It's not a question of do people want to own Petco, it's a sense of where do people want to own it."Investors continue to show a strong preference for highly-rated credits and pricing on two deals has tightened this year as cash-rich investors try to buy loans that they are confident will perform well. Pinnacle Foods sliced pricing on a $550 million term loan rated Ba2/BB+ to 300 basis points over Libor from 350 basis points last week, while fiber network company Zayo cut the price on a $400 million acquisition term loan to 350 basis points over Libor from 375 basis points. Selected lower rated credits have also been able to cut pricing. B1/B-rated contact lense maker 1-800 Contacts tightened spreads on a $500 million buyout loan to 425 basis points over Libor with a step down to 400 basis points over Libor with a 1 percent floor from original guidance of 450 basis points to 475 basis points.
U.S. consumer spending cooled in January as demand for automobiles and utilities fell, but inflation recorded its biggest monthly increase in four years, raising the probability of an interest rate hike from the Federal Reserve this month. The tepid gain in consumer spending added to weak housing starts, equipment spending and construction data in suggesting economic growth remained moderate early in the first quarter after slowing in the final three months of 2016. Despite the softness on the demand-side of the economy, the manufacturing sector recovery is gaining steam. Factory activity hit a 2-1/2-year high in February, other data showed on Wednesday."A weak start to the year for consumers suggests a downside risk to first-quarter growth prospects, though it likely won't quell recent chatter about a March Fed rate hike," said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. The Commerce Department said consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased 0.2 percent after rising 0.5 percent in December. Consumer spending is likely to remain supported amid promises by the Trump administration of sweeping tax cuts and increased infrastructure spending. In a speech to Congress on Tuesday night, President Donald Trump said his economic team was working on a "historic" tax reform that would slash corporate taxes. Trump promised "massive" tax cuts for the middle class, but offered no further details. Consumer confidence has surged following Trump's Nov. 8 election victory, hitting a 15-1/2-year high in February. In January the personal consumption expenditures (PCE) price index increased 0.4 percent - the largest gain since February 2013 - after rising 0.2 percent in December. In the 12 months through January, the PCE price index jumped 1.9 percent. That was the biggest year-on-year gain since October 2012 and followed a 1.6 percent increase in December.
Excluding food and energy, the so-called core PCE price index rose 0.3 percent in January. That was the biggest increase since January 2012 and followed a 0.1 percent gain in December. The core PCE price index increased 1.7 percent year-on-year after a similar gain in December. The core PCE is the Fed's preferred inflation measure. While still below the U.S. central bank's 2 percent target, inflation is now in the upper end of the range that Fed officials in December estimated would be reached this year."COMPELLING" CASE FOR RATE HIKE
The strong inflation readings come a day after New York Fed President William Dudley said the case for further monetary policy tightening had become a "lot more compelling."Prices for U.S. Treasuries fell, with the yield on the interest-rate sensitive 2-year note US2YT=RR hitting its highest level since August 2009. Fed funds futures were pricing in about a 65 percent chance of a rate hike at the Fed's March 14-15 policy meeting. The dollar touched a seven-week high against a basket of currencies. Stocks on Wall Street rose, with the Dow Jones Industrial Average . DJI breaching the 21,000 mark for the first time ever as investors focused on Trump's comments. The U.S. central bank has forecast three rate increases this year. The Fed hiked its overnight interest rate last December. In a separate report on Wednesday, the Institute for Supply Management said its index of national factory activity increased to a reading of 57.7 last month, the highest since August 2014, from 56.0 in January.
A reading above 50 indicates an expansion in manufacturing, which accounts for about 12 percent of the U.S. economy. Some of the increase likely reflects a surge in business confidence following Trump's election. But that has not been matched by a strong increase in business spending on capital goods. Business spending on equipment rose moderately in the fourth quarter and appeared to weaken in January, data showed this week."For now, businesses and households appear confident, but have yet to act on that confidence," said Michael Feroli, an economist at JPMorgan in New York. "When it comes to calculating GDP it is the hard data that matters, and so far the hard activity data for the first quarter has been disappointing."Rising inflation is eroding consumer spending. When adjusted for inflation, consumer spending fell 0.3 percent in January, the first drop since August and the biggest in three years. It increased 0.3 percent in December and January's drop implies consumer spending will probably not provide a big boost to GDP in the first quarterConsumer spending increased at a 3.0 percent annualized rate in the fourth quarter, helping to blunt some of the impact on the economy from a wider trade deficit. The economy grew at a 1.9 percent rate in the fourth quarter and the Atlanta Fed is forecasting GDP rising at a 1.8 percent pace this quarter. Another report from the Commerce Department on Wednesday showed construction spending declined 1.0 percent in January. Personal income rose 0.4 percent in January after gaining 0.3 percent in December. Income at the disposal of households after accounting for inflation, fell 0.2 percent, the first decline since October 2013.