Speculative-grade borrowers are issuing shorter-term bank debt at lower interest-rates by turning to collateralized loan obligations that will soon wind down.
Companies from US Airways Group Inc. (LCC:US) to Spectrum Brands Holdings Inc. (SPB:US), the maker of George Foreman grills, have raised a record $10 billion of loans this year from CLOs facing the end of their so-called reinvestment-periods that limit their ability to buy longer-dated debt, according to Credit Suisse Group AG. Spectrum Brands obtained $1.15 billion in financing including a four-year portion paying half a percentage point less interest than a six-year piece, according to data compiled by Bloomberg.
The window to invest is closing for an unprecedented $81 billion of CLOs this year, up from $54 billion in 2012, according to JPMorgan Chase & Co. The need for CLOs created before the collapse of Lehman Brothers Holdings Inc. to wind down is giving some companies with below investment-grade ratings the chance to reduce borrowing costs with shorter-term loans in exchange for more refinancing risk.
Leveraged loans will increasingly consist of two pieces with different maturities, one having an earlier due date that meets the needs of the growing number of CLOs that are reaching the end of their reinvestment periods, Tim Broadbent, head of Americas leveraged loan syndicate at Barclays Plc, said in a telephone interview.
CLOs are a type of collateralized loan obligation that buy high-yield loans and package them into securities of varying risk and return. When CLOs are in their reinvestment period, they can reinvest principal proceeds back into the loan market. Once they get to the end of their reinvestment periods, those proceeds will be directed toward repaying the fund’s liabilities.
Michelle Mohr, a spokeswoman for US Airways, and David Prichard, a spokesman for Madison, Wisconsin-based Spectrum Brands, declined to comment on the companies’ financings.
Credit Suisse arranged $1.15 billion of term loans helping Spectrum Brands, whose products include Black & Decker home appliances and Remington hair dryers, to refinance more expensive bonds, Bloomberg data show. The $850 million four-year piece pays interest at 2.25 percentage points more than the London interbank offered rate, with a 0.75 percent floor on the lending benchmark. The $300 million six-year portion has a spread of 2.75 percentage points and the same Libor floor.
“The borrower loved the lower-cost capital,” Jeff Cohen, co-head of U.S. loan capital markets at Credit Suisse, said in a telephone interview. “They have their place and time for the right kind of issuer.”
Standard & Poor’s estimates Spectrum Brands will produce between $550 million and $600 million of free cash flow this year and next. The firm increased the company’s credit rating to B+, or four levels below investment-grade, citing $50 million of interest cost savings from the refinancing and its ability to reduce debt.
Barclays arranged $1.2 billion of term loans including a shorter duration carve-out for Fairmount Minerals Ltd., helping the Chesterland, Ohio-based company finance its purchase of FTS International’s sand-mining business.
A $325 million portion, due in March 2017, was offered to investors at a rate of 4 percentage points more than Libor with no minimum on the lending benchmark, according to a person with knowledge of the deal who asked not to be identified because terms are private. An $885 million piece that matures in six years has the same spread, with a 1 percent floor on Libor. Three-month Libor (US0003M), the variable benchmark rate for leveraged loans, was set at 0.262 percent on Aug 23.
Borrowers seeking shorter-dated maturities need “adequate free cash-flow,” Cohen said.
US Airways, the carrier merging with AMR Corp.’s American Airlines, obtained $1.6 billion of term loans in May to refinance debt and split them into separate maturities.
The interest rate on the six-year $1 billion piece was set at an initial 3.25 percentage points more than Libor, compared with the 2.5 percentage point spread for the $600 million portion that has a maturity of 3 1/2 years, Bloomberg data show. Each loan has a 1 percent floor on Libor.
After the merger, which the U.S. Justice Department is seeking to block, the interest rate on both pieces would decrease by 25 basis points. A basis point is 0.01 percentage point.
Structuring a loan to include a shorter-term piece is less common in buyout financings because private-equity firms typically prefer to push out the risk of refinancing as far as possible, Broadbent said.
“One place you are going to see them is for bigger deals where you are looking for sheer capacity,” he said. “With a $4 billion or $5 billion term loan you are going to want to make sure you can dip into every pocket in order to get that done.”
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