The first vintage of leveraged loans to be issued during the Federal Reserve’s rapid-fire pace of rate hikes — and therefore higher margins — have come out of, or are nearing the end of, soft call periods. With the asset class also clocking its best year for performance since the Global Financial Crisis, more loans are entering repricing territory.
Indeed, repricing activity, which in lowering interest expenses for issuers also eats into returns for lenders, was busier in September than any month since February 2021.
More could be coming through the pipeline, LCD data shows, with lenders to companies rated BB/BB- most at risk to seeing the interest rate shaved on their holdings.
Looking first at the current uptick, 20 loans repriced last month, affecting $22 billion of facilities. This is up from $13.7 billion in August and compares to an average monthly total of $1.5 billion in the first six months of the year.
Of those 20 facilities, 80% launched after the Fed began its campaign in March 2022 to raise its benchmark interest rate to the highest level in 22 years.
On a quarterly basis, the $42 billion of repricings in the third quarter was the highest since the repricing wave in the first quarter of 2021.
In the year to date, companies holding nearly $52 billion of loans have reduced margins through a loan repricing. Though up from just $10 billion in the first three quarters of 2022, it falls far short of the 2021 repricing surge when during the same period, $208 billion had repriced.
On average, borrowers that repriced loans this year have trimmed 56 bps from the interest cost over the benchmark rate.
With leveraged loans lacking meaningful call protection (at least compared to high yield bonds), as prices reach par, repricing starts to look attractive for issuers seeking to reduce borrowing costs on an existing credit — as opposed to the more cumbersome process of placing a new loan. Given the need to stay fully invested, lenders have typically been willing to accept the repricing and take the same loan at a lower nominal spread.
This is especially true during periods of limited primary market activity—to wit, 2023 is running at the lowest volume for new-issue supply (excluding refinancings) since 2009. Furthermore, by LCD’s measure, demand has outstripped supply in 11 of the past 12 months.
With that said, a look at the broad-based price environment at the end of September showed 8.3%, or $116 billion, of loans in the Morningstar LSTA US Leveraged Loan Index are trading at high enough levels to be called. Though a sizable amount, it remains below the trigger point of past repricing waves.
As the following chart shows, there is a high correlation between elevated repricing activity and an elevated share of loans in the index priced above par.
Looking more closely, during the last repricing wave in 2021, the busiest period for activity was in January of that year, and while prices had started to tick up in mid-December 2020 (with the share of loans above par crossing into the double digits), repricing activity did not start in earnest until Jan. 11, when the share of loans priced above par in the index hit 40%. In fact, 51 of the 52 September 2021 repricings happened after the index crossed that 40%-over-par threshold.
In the repricing wave of late 2019 and early 2020, repricing activity swelled as the index share of loans above par hit 50%.
While the current price breakdown of the index does not yet lend itself to dramatic spikes of early 2021 and early 2020, a contingent of loans placed at relatively wide margins during the period of rate hikes could fuel the next repricing trade.
Repricing watch
Of the loans already outside of prepay fee periods, data from PitchBook | LCD and the Morningstar LSTA Leveraged Loan Index show the BB/BB- category is most at risk of a repricing spike, as it has a greater volume of loans priced at 99 or higher that are above current new-issue clearing spreads.
Drilling down and looking first at B/B+ loans, just over $300 billion of these loans outside of call protections are priced at 99 cents on the dollar, or higher. Some $53 billion of those loans currently pay 425 basis points (or more) above the base rate, versus an average clearing spread of 400 bps in the new-issue market.
Roughly $56 billion of B/B+ loans, with expired prepay fee periods, are priced in the secondary market above par — or the prepay level. However, only a quarter of these loans have current spreads which are at least 25 bps higher than the current clearing level in the new-issue market.
Further up the ratings scale, $169 billion of loans rated BB/BB- with expired prepay fee periods are priced at 99 or higher, and $42 billion are at par or higher. Out of the latter cohort, at least $27.3 billion have spreads above the current new-issue level of 273 bps. In fact, that September new-issue spread reading was the lowest level since April 2022, down from 358 bps in January. Within the 99 or higher cohort, roughly $95 billion of loans could be a target for a repricing, with a higher spread than the current clearing level in the primary market.
Broadening this analysis to include loans due to come out of call protection in the next six months (in addition to loans with expired call periods), reveals a jump in B/B+ rated issuers with room to potentially lower costs on their facilities.
Nearly $32 billion of loans priced above par carry a discount margin of 425 bps and higher. Of loans priced at 99 or higher, with a discount margin of 425 bps or higher, nearly $80 billion are either out of call periods, or will be in the next six months.
In the BB/BB- loan cohort with expired prepay fee periods, or with prepay fee periods due to expire in the next six months, $37.4 billion priced at par or higher have spreads above the current new-issue level of 273 bps. This climbs to $112 billion for BB/BB- companies with loans priced at 99 or higher and with spreads above the 273 bps new issue clearing level.
While the lack of new issue supply (and therefore alternative paper to put cash to work) will likely support repricing activity, primary spreads have also tightened, presenting an opportunity to cut costs.
For single-B rated companies, the average spread offered above the benchmark rate to clear new loan issues in September was 400 bps. Six months ago, companies paid 443 bps on average, and in July 2022, that was as high as 510 bps.
For BB rated companies, the average spread in September was 273 bps. At the beginning of this year, the average spread commanded by investors was 358 bps.
Spread adjustment
In addition to lowering pricing terms, borrowers are slowly eliminating credit spread adjustments that were placed to bridge the gap between Libor and the replacement term SOFR benchmark.
LCD this year has tracked 29 repricings of loans originally issued in 2022 or 2023, of which 13 tied interest payments to a CSA. Only four removed the CSA which in all cases, had previously added 10, 15 and 25 bps to one-month, three-month and six-month interest periods, respectively. The four issuers to eliminate CSAs were Crocs, MKS Instruments, AZZ, and GFL Environmental.
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