LPC: US Q1 syndicated lending sank, investors now bargain-hunting

By Lynn Adler

NEW YORK, March 31 (Reuters) - Recession fears and sinking oil prices in early 2016 overshadowed a return of investor risk appetite in the past six weeks, dragging U.S (Other OTC: UBGXF - news) . syndicated lending to the lowest quarterly volume in more than five years.

The US$312bn of loans issuance in the first quarter plunged 37% from the fourth quarter, and 19% from the first quarter a year ago, to the lowest since US$245bn in the third quarter of 2010, according to Thomson Reuters LPC.

The U.S. economic outlook brightened as the quarter progressed, and oil prices bounced from more than 12-year lows in mid-February, pushing aside some barriers steering investors away from leveraged loans and other high-yield debt.

The deal pipeline remains contained, but could gather steam if the economy continues growing modestly, investors and strategists agreed.

The quarter's issuance drop extended last year's 6% slide to about US$2trn, which was driven by market volatility, swooning oil prices, regulatory constraints on higher-risk debt and uncertainty over Federal Reserve policy.

"You had a tale of two halves during the first quarter," swinging about mid-way through from risk-off to risk-on, said Jonathan DeSimone, a managing director and portfolio manager at Sankaty Advisors.

ECONOMY, EARNINGS, ENERGY

In the first half of the quarter, concerns that the U.S. would slip back into recession, while oil prices set fresh lows and stoked default worries, kept retail investors yanking money from loan funds and Collateralized Loan Obligation (CLO) funds sidelined.

After withdrawing from loan funds for 32 straight weeks, retail investors turned into net buyers during the first three weeks of March.

Formation of CLOs, the biggest buyers of leveraged loans, also picked up, though they are seen playing a lesser role generally due to regulations requiring CLO managers hold 5% of their funds. This risk retention rule takes effect in December.

CLO issuance was about US$8bn in the first quarter, seen climbing to US$10bn in the second quarter, according to LPC. A considerable downsizing, though, is seen following the 20% issuance drop in 2015 to about US$99bn.

"When you look out into the second quarter, the wild card is going to be earnings," said DeSimone. "We don't have a huge calendar, which is good for the market, as we also don't have strong CLO formation or retail flow."

Much of the first quarter was dominated by credit issues in the oil and gas, and metals and mining sectors, as well as the outflows from retail funds and slow CLO creation, said Scott Page, portfolio manager at Eaton Vance (NYSE: EV - news) .

Average bids on the 100 most widely held leveraged loans fell to 95.3 cents on the dollar in February from 96.6 at year-end, before bargain seekers surfaced to lift the bid to 97.2 as of March 30.

A year ago, the average bid was still higher, near 100.

"The technicals/flow story that was so negative for bank loans and the primary cause of bank loans trading lower, has relented," Page said. "As a result, you've seen the selling pressure on the most liquid names come off, and as soon as that pressure was taken off, they lifted in price pretty dramatically during the first quarter."

DEMAND NOW OVERTAKING SUPPLY

Investment banks that got stuck with loans on their balance sheets last year have been less aggressive in structuring new deal terms, tilting the balance more to a buyer's market than an issuer's market, Page said.

Higher yields are also enticing buyers back.

After peaking at 7.33% in February, the highest since June 2012, increased demand helped tug average yields on first-lien institutional loans down to 6.50% in March.

Still, the average yield of 6.53% in the first three months of this year was higher than 6.14% in the second quarter and the highest quarterly average since the second quarter of 2012.

"The dynamics have definitely shifted since the beginning of the year," with demand now outstripping supply, said John Fraser, managing partner at 3i Debt Management US.

The quarter's lending drop was most pronounced among investment grade issuers. At US$141bn, issuance fell 43% from the fourth quarter to the lowest since US$121bn in the first quarter two years ago.

For leveraged loans, the US$112bn issued was a 29% drop from the prior quarter and the lowest since US$101bn in the fourth quarter of 2011.

"Whether this (market traction) can be sustained all depends on new-issue supply, the overall economic environment and if people continue to feel comfortable taking sub-investment grade credit risk," Fraser said. "Right now the economy is in decent shape and we see very, very little new-issue supply on the horizon." (Reporting by Lynn Adler; Editing By Michelle Sierra, Jon Methven (NZSE: MVN.NZ - news) )