Outlook 2012: Leveraged loan spreads, OIDs direction unclear; Libor floors predicted as flat

By Sara Rosenberg

New York, Dec. 30 - Spreads and original issue discounts on leveraged loans are expected by some to move up on average in 2012 from 2011, but others think that pricing could come down if the economy cooperates. And, while Libor floors are anticipated to remain part of the landscape, levels are estimated to be pretty much unchanged.

"Spreads may move up and down within 50 basis points depending on inflows/outflows. We are seeing much more volatility/correlation related to the equity market, which is new for loans. With cost of capital rising and balance sheets getting tighter, we see more upward pressure on pricing than downward," a sellside source said.

Meanwhile, a market source remarked that his firm expects spreads "to go up across the board in 2012 as Libor is expected to remain low and liquidity costs historically high."

He put the average spread for B-rated institutional loans at around Libor plus 480 bps in 2011 and for BB-rated loans at Libor plus 340 bps. In 2012, he expects B-rated deals to price around the Libor plus 500 bps to 550 bps area and BB-rated deals to price around Libor plus 350 bps to 400 bps.

A market professional also expects coupons to move higher in 2012, pointing to the "slow economic recovery and continued problems out of Europe" as the drivers. He added that the "best case scenario" would be spreads staying the same.

Offering a different viewpoint was a buyside source who claimed that spreads will tighten on "lower issuance and/or better economy."

Middle market pricing

Looking at middle market deals, the sellside source put average spreads in the first half of 2011 at Libor plus 500 bps to 550 bps and in the second half of the year at Libor plus 600 bps to 650 bps. His estimate for 2012 is Libor plus 600 bps on average.

There was a volatile secondary market during the back half of 2011, the source said.

"Investors felt the sting and are careful. They want liquidity so they can get out of a name. Less liquid middle market deals will need a little extra spread to get done," the sellside source continued.

At minimum he thinks middle market deals will need to be priced at Libor plus 600 bps with a 1.5% Libor floor and an original issue discount of 98 to get done in 2012, and the "any deal could easily go to 650 [bps] at 97."

OIDs tighter or wider?

On the topic of original issue discounts, different sources offered varying opinions, with some thinking they'll tighten and others estimating a widening, although not by much.

"I see pressure to get OIDs back to 98. 97 is tough for sponsors," the sellside source remarked, adding that he found the average original issue discount to be around 97½ in 2011.

"OIDs are going to remain in the current investor friendly environment - probably wider with the average being in the 2 to 3 points area," the market source said.

The market professional put the average original issue discount in 2011 at 96 and expects that to tighten in 2012 to 98. "OIDS will remain in 98 to 99 context as investors will continue to demand the OID construct to generate needed returns," he added.

As for the buyside source, he said that OIDs are an "important part of yield boost which will stay important as long as Libor stays low. Level depends on market demand, which I view as fairly similar year to year, so moving in a 97-99 range depending on quality.

"OIDs get to 99 when demand is very high, [which we saw in the] early part of this year with retail inflows or for great credits, and 97 when demand is so-so. When you start talking 96 you're getting the feeling of a tough credit or a tough market, and barring a Europe blow up, I don't expect the latter, so 97-99 is a guess. I think the average for [2011] will look somewhat like that but there are some outliers that might skew a calculated average," the buyside source concluded.

Libor floors to hold steady

Regarding Libor floors, sources agree that deals will continue to offer this feature and the general estimate seems to be that they will remain in the 1.25% to 1.5% area.

"Libor floors remain as long as yield needs stay high and Libor low. About the same, 1.5%, would not surprise me," the buyside source said.

A Libor floor of 1.5% is standard, the sellside source remarked, noting there was some pressure for 1.25%.

"We are offering the lower floor only for BB rated issuers," the source added, noting there was "not much push back from sponsors."

"Considering the current Libor rates, we expect the Libor floors to remain in 2012. The average Libor floor was around 130 to 140 bps. We expect it to remain stable in 2012," the market source added.

The market professional was pretty much in agreement, saying that Libor floors will remain in the 1.25% to 1.5% context "as rates will not rise enough to eliminate the floor."

Covenants sticking around

Sources anticipate that covenants will still be an important factor in deals in 2012, with a good majority of new issues having standard maintenance packages and very few being able to go the covenant-light route.

"[Covenant]-light is dead. Have seen some deals with springing covenants but only for large cap, tier 1 sponsor deals," the sellside source said.

When asked about the 99 Cents Only Stores credit facility that was done in December and moved to a covenant-light structure as a result of strong demand, the sellside source said that it was a "borderline" large cap tier 1 sponsor deal and "pretty amazing that deal got done covenant-light."

"Cov-light depends on supply and demand, period. Expecting a similar balance next year, so 20% plus cov-light driven by sponsored deals would not be surprising," the buyside source explained.

Meanwhile, the market source said that his firm expects "more covenants in 2012. The covenant-light deal volume is likely to diminish, if not disappear almost entirely, from the $59 billion we have seen so far in 2011."

The market professional's take on covenants is that most deals will have maximum leverage and minimum interest coverage requirements. "Cov-light was part of the market in 2011 but only for the right credits. Investors [were] not willing to stretch to go cov-light for borderline situations. It will be the same in 2012," he concluded.

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