Big Buffers
To avoid eating into the fees they earn to underwrite the debt or, in the worst-case scenario, taking outright losses, banks have been including bigger buffers, known as market flex, into the terms of their commitments.
Banks are seeking flexibility to syndicate loans at rates that are as much as two percentage points higher than those they initially indicate to borrowers, compared to 1.25 to 1.50 percentage points of flex before Covid, the people said.
With investors demanding lower initial prices on risky debt, the type of loans that banks used to backstop at around 97 cents on the dollar are now being underwritten in the low 90s, the people said. Big discounts can be particularly attractive to CLOs that are looking for quick returns on newly issued debt to repair their portfolios.
For bonds, the interest rates that determine when banks start eating into their fees have risen to 11% or 12%, even for secured notes, compared to below 10% before Covid, they added. That’s even as other LBO bonds currently trade at yields of around 8%.
Still Worried
Bankers first turned cautious in late February, when the virus was already spreading through Europe but before any shutdowns began in the U.S.
One of the last deals to be signed during that time, a $295 million loan for CD&R’s acquisition of British health-care services company Huntsworth Plc, was also underwritten in the low 90s, some of the people said.
Royal Bank of Canada and Barclays funded the deal in May to allow the acquisition to close and may bring it to the broadly syndicated market over the coming weeks, according to one of the people. Representatives for RBC and Huntsworth declined to comment.
Read more: Wall Street warning to corporate America: get cash while you can
Bankers’ reluctance to loosen underwriting terms as markets have rebounded shows that much of Wall Street is still worried about new spikes in volatility and the pace of the economic recovery amid signs the virus is still spreading.
They have reason to be cautious.