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By Matthew Quinn
The U.S. leveraged loan market in 2010 will build on the recovery that began to take hold during the second half of last year, according to research released by Fitch Ratings on Monday.
New issuance levels remain well below historical levels, but have begun to improve in recent weeks. The ratings agency currently estimates that fourth quarter 2009 issuance exceeded $84 billion, well above the $38 billion of issuance in the same period a year earlier.
It's not just the volume of deals that's encouraging, but the kinds of deals that can now find financing. Recent weeks have seen the return of sponsored deals, including leveraged buyouts, mergers and acquisition activity and special dividend deals, as well as the structuring of some of the first new collateralized loan obligations seen in over two years, Fitch noted.
Secondary price levels, which began 2009 at approximately 60.5 cents on the dollar largely due to forced selling, have now recovered to over 87 cents on the dollar.
"Although the price improvement was initially driven by distressed and opportunistic investors, recent gains have been the result of more traditional investors reinvesting proceeds of recent loan pay-downs from new high yield bond issues," Fitch wrote.
In addition to improved issuance levels and rising prices, there were numerous structural changes to loan facilities in 2009, including wider LIBOR spreads on new or amended loan facilities, stronger covenant packages, improved collateral packages, call protection, LIBOR floors, shorter maturities and reduced senior secured debt levels.
Fitch expects new issuance in 2010 to be marginally higher than the $240 billion in loans issued last year. New issuance will benefit from the recent pick-up in M&A and LBO activity, as well as the re-emergence of CLOs but won't come anywhere near the peak of nearly $700 billion in 2007.
Fitch expects spreads to tighten on new issuances as investors' risk tolerance gradually improves. New facilities will also likely continue to have LIBOR floors, although original issue discounts should continue to gradually shrink as investor demand levels increase.
Of course, even as demand has been improving, investors remain largely skittish, as can be seen in the quick turn of fortunes in the bond market.
And despite its forecast for strong demand, Fitch believes leveraged loan structures are likely to remain conservative in 2010. The market's reduced tolerance for highly leveraged deals will likely force total leverage levels to remain well below levels seen prior to mid-2007. This, in turn, could force strategic buyers and private equity sponsors to contribute a greater percentage of equity to complete leveraged deals.
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