Outlook 2014: Spreads, discounts, Libor floors could come in further

By Sara Rosenberg

New York, Dec. 31 - Spreads may tighten in 2014 versus 2013; however, with levels as low as they were over the past year, there are some sources that are unsure as to whether they can see much more downward movement. As for original issue discounts and Libor floors on leveraged loans, those are expected to remain part of the landscape but at a smaller scale.

"If we take as a predicate that the Fed will not raise rates in 2014 and we won't have a recession or big technical swoon, I think we will grind tighter in 2014. That means repricings [and] lower coupons," a buyside source remarked.

"A wild card is CLO arbitrage. With AAAs near 150 and spreads grinding tighter, the arbitrage might not work for double digit equity returns. While everybody is focused on the retail flows [up around $60 billion for the year], the fact is that CLO demand was $75 billion and counting, so if the arbitrage does not work a significant source of demand will be lacking. That could restrain spread tightening in 2014.

"Some deals that would have been brought to market would not be brought under such circumstances - lack of CLO demand does not imply a giant supply/demand imbalance - but the effect on pricing would be clear. If something happens that suggests the Fed will be easy until at least 2017 the retail flows might not be positive either. We have had a very long streak," the buyside source explained.

Another source said that he expects "spread compression due to strong demand for second-lien loans." On first-lien debt, he believes average spreads will be in the Libor plus 375 basis points area versus the Libor plus 400 bps area in 2013.

A sellside guy, meanwhile, remarked that "spreads seem to be about as tight as they can be, though they were arguably a bit tighter in February, so a safer bet is that there will be some widening. That said, we have been getting some positive data lately and I wouldn't expect any big movement."

According to the sellside guy, the average Libor spread for B2/B was somewhere around 375 bps to 400 bps.

Yet another source remarked that spreads will likely stay the same in 2014 as there is not a lot of room to go tighter from 2013.

Data from Markit indicates the average spread for first-lien deals done in 2013 was Libor plus 425 bps, and the average spread for second-lien deals done in 2013 was Libor plus 800 bps.

OIDs expected to lessen

Original issue discounts are anticipated by sources to continue to shrink in 2014 due to the overall strength in the loan market.

One source remarked that OIDs will likely be tighter in 2014 than in 2013 as "issuers continue to see upper hand," and he expects that deals will be offered more in the 99½ to par range.

The sellside source agreed, saying that offer prices have "moved to one point or less, and I would expect them to continue to tighten though not go away altogether for new issues."

And the buyside guy said that he expects thinner OIDs in 2014 and that discounts could even go away altogether, barring any unforeseen event.

Markit has the average OID for 2013 at 99.

Libor floors could tighten

Libor floors are also expected to come in with strong demand, with one sellside source saying they'll likely tighten to inside of 1%.

Another source remarked that that 1% to 1.25% was the average Libor floor in 2013 and he anticipates a 1% floor for most of 2014 until there is a drastic change in the rate outlook.

The buyside source said that he expects Libor floors to stay but likely to be in the range of 0.75% to 1%.

"Sure, 75 bps floor and 99.5 OID is a good ballpark for the early part of 2014, but that can get tweaked easily to 100 bps floor and 99 if demand slows for any reason, and tweaked to no OID if demand is high," the buyside source added.

Data from Markit has the average Libor floor for 2013 at 1%.

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