NEW YORK, Oct 1 (LPC) - Lenders played it safe in the third quarter. At US$463bn, total US syndicated lending dropped 28% from the previous quarter and marked the lowest July-September tally since 3Q16, failing to match lenders’ expectations for a strong start to the second half of 2019.
Instead, caution crept into the market. The volatility of early August, whose impact was initially contained, eventually gave way to a broader sense of uncertainty and lack of visibility, especially around trade policy and tariffs, but also regarding which borrowers are best poised to weather a downturn.
“What would be helpful is a sense of what the new normal is so we can adjust to it. The constant back and forth is almost creating tariff fatigue,” said a credit investor of the unresolved negotiations around trade policy. “Tell us the answer and we’ll work on it.”
A growing sense of caution ultimately prevailed, dampening lender and investor appetite for risk even as banks and institutional investors have ample capital to lend.
“Uncertainty is making it challenging to execute on large acquisitions,” said a source of the lack of large-scale tie-ups that typically help buoy issuance numbers.
Investment grade M&A volume has declined with each consecutive quarter in 2019, landing at US$40.45bn in 3Q, down from US$68.74bn in the second quarter and about half of the US$82.65bn inked in the first three months.
“Risk of market disruption due to exogenous shocks—trade wars, BREXIT, impeachment, Hong Kong—is having a dampening effect on M&A activity,” said a banker. “That said, the I-grade loan market is resilient and banks are well positioned to meet their clients’ financing needs.”
On the leveraged loan side, at US$65.58bn total M&A volume is down compared to a year ago, but it has been roughly flat on a quarterly basis in 2019. Leveraged buyout issuance is also down year over year. In the third quarter, loans backing leveraged buyouts amounted to US$29.62bn compared to US$48.18bn a year ago.
The Federal Reserve also cut interest rates twice during the quarter. The first cut since 2008, a quarter point reduction, came in July, followed by another quarter point cut in September, bringing the Fed’s target rate to a range of 1.75 to 2 percent.
Still, borrowers did not flock to the loan market before nor after the Fed’s actions, despite interest rates being at historically low levels and making it an opportune time to lock in money ahead of the economic downturn that is now widely expected to come sooner than later.
Lending to investment grade companies was US$208bn in the third quarter, falling from US$326bn last quarter, but coming in ahead of the US$199bn recorded a year ago, which was notably the lowest period on the books for 2018.
Leveraged borrowers tapped the market for a total of US$181bn in loans down from US$215bn in the second quarter and US$203.5bn the third quarter of last year.
Total new money volume, including loans to investment grade-rated companies and leveraged borrowers, declined to US$160.14bn in the third quarter compared to US$209bn last quarter and US$198bn for the same period last year.
With lenders and investors taking a more cautious stance as they parse Fed interest rate policy, analyze yield curve signals, economic growth forecasts and consumer confidence, as well as a borrowers’ creditworthiness in times of economic distress, a strong preference for top tier credits in non-cyclical industries took hold in the third quarter.
“There seems to be a bifurcation in strong investment grade and non-investment grade credits,” the source said. “Down the credit spectrum, you’re seeing investors becoming choosier.”
Leveraged loan investors notably exerted more discipline in the third quarter, asking routinely to be compensated for taking additional risk from requests for lender-friendly documentation changes to demanding higher pricing.
Automotive artificial intelligence firm Cerence Inc, for example, increased the spread on a US$425m by 125bp to 600bp over Libor to get the deal over the line and made a series of amendments to the terms governing the loan, which backs the company’s spin out from parent Nuance Communications.
Digital imaging company Shutterfly twice hiked the pricing on a US$1bn term loan backing the company’s sale to Apollo Global Management and bowed to investor demands for other changes during syndication.
At least seven loans were pulled after the deals failed to attract enough investors, including a US$900m term loan for coal producer Peabody Energy and a proposed US$700m term loan for accessories retailer Claire’s Stores.
What will the fourth quarter bring this year? Typically, the last three months of the year are very busy for loan bankers as corporates and private equity sponsors look to wrap up deals before year-end. But 2019 may be a different animal.
The variables are many. The impeachment inquiry playing out in Washington with the election year around the corner, on top of any number of potential geopolitical flareups could make or break the final quarter of the year. Lenders and borrowers may very well sit on the sidelines, or the possibility of future uncertainty may compel them to act now before the fog limits visibility even more.
Already, in a blow to the bank market, real estate company WeWork pulled a planned initial public offering as equity investors balked at the company’s financials.
The successful completion of the IPO by December 31 was a critical hurdle the company had to clear in order to access a US$6bn loan commitment from a syndicate of 13 banks. The deal would have given a solid boost to the fourth quarter syndicated loan tally. (Reporting by Leela Parker Deo with additional reporting by Daniela Guzman; Editing by Michelle Sierra)