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LONDON, Jan 13 (Reuters) - Lenders to European leveraged loans are seeing their allocations scaled back to such an extent that investors have been forced to inflate orders in a bid to attempt to secure decent ticket sizes.
Scale-backs in the market during the last quarter of 2016 were at their highest level since the financial crisis, as a deluge of money from a raft of new CLOs and managed accounts flooded into the few new-money deals that were available.
"Scale-backs are brutal at the moment," a leveraged finance banker said.
For example, a 125m add-on for Belgium-based Continental Foods in December resulted in a 1bn order book.
The trend is set to continue into 2017 while the technical dynamic of high demand and low supply dominates.
"Until there is a massive pick-up in M&A there is going to be a demand and supply imbalance. People are disciplined around the edges but it is hard to be on every situation," a second leveraged finance banker said.
A 50m add-on for French call centre operator Webhelp has seen some significant orders and the books are already full, despite commitments not being due until January 17, a source close to the deal said.
Add-ons have proved very popular for investors already familiar with a credit. Of late, many investors have been putting in ticket sizes for a large proportion of a tranche, if not the whole tranche.
"People have shown healthy appetite for deals out there and in some cases given orders that are unrealistic in the context of certain deals, even if they are happy to be hit with the full allocation," a third leveraged finance banker said.
INFLATED ORDERS Some funds are inflating orders beyond approval levels, in order to try to minimise the effect of scale-backs. In one case, an investor put in a ticket size of around 150m when it wanted 50m of paper, a source said.
Investors are also relaying to arrangers what allocations they want and leaving it to the discretion of the banks to write down the ticket sizes needed to ensure they get the desired amount after a scale-back, an investor said.
Smaller funds have also had to inflate orders just to get a look-in on a deal.
"It has been quite difficult and challenging for smaller players, as up until late Q3/Q4 they were locked out of earlybirds where whole deals were placed with the bigger funds. The smaller funds realised they had to be smarter to engage in deals and they are doing that by giving larger tickets to get through the door," a leveraged loan head said.
Most banks are against the practice of inflating orders, but they differ when it comes to their method of scaling back allocations. While some banks scale back evenly across a book, others will give preference to some of the larger funds, which will then end up with bigger tickets, leaving a large number of smaller funds to divide up a fraction of the deal.
There have been a lot of occasions when smaller funds have been allocated the minimum hold on a deal of 1m and in some deals the minimum amount has been reduced to 500,000.
A lot of it comes down to how influential and hands-on a sponsor is. Some sponsors will run a book and determine the composition of the deal, restricting it largely to the funds they know well.
Although zero allocations are not common practice in the loan market, an account could be zeroed if it doesn't get on with a sponsor or desk.
"No-one has officially been zeroed, unless someone has ticked off a sponsor or crossed someone off the wrong way. We have heard from accounts they have been zeroed anecdotally," the second leveraged finance banker said.
If the technical dynamics seen in 2016 continue into 2017, which is expected for the first quarter at least, then the loan market could start seeing zero allocations.
"We haven't done a zero yet. In the high-yield bond market it is common practice, but we haven't really seen that yet in loans. There are books where the smaller market participants are getting the minimum hold but it hasn't got to the point where it is so rude that funds are getting zeroed - but we could get there this year," a syndicate head said.
Technical pressure is driving pricing tighter and UK forensic sciences group LGC and Webhelp are in the market repricing deals from January and February last year, respectively.
Pricing is likely to continue to tighten and by March, the market could be swamped with deals that reprice the repricings conducted in the last quarter of 2016, once six-month soft call protection expires.
Tightening CLO prices will make it easier for CLOs to remain invested in the lower-yielding credits, fuelling more oversubscriptions and scale-backs.
For the foreseeable future, 2017 is a borrowers' market, while investors will continue to suffer and struggle for paper, a second investor said. (Editing by Christopher Mangham)