February 23, 2017 - As the institutional loan market’s excess demand continues into its eighth month, the benefits are drifting down the capital stack. To wit, after $100 billion of (primarily first-lien) repricing in January, second lien loans may be on deck.

First, a recap on excess demand: While the arbitrage remains challenging, CLO formation has picked up. With CLOs for GSO (AAAs at 126 bps!) and KKR pricing on Wednesday, February CLO formation climbed to $6.26 billion as of mid-week, LCD reported. In addition, following more than $4 billion in loan mutual inflows in January, there has been another $2.7 billion of inflows (weekly reporters only) coming in February. (See ThomsonReuters LPC’s Leveraged Loan Monthly for January data and LCD for a mid-February update.) Meanwhile, repricing churn notwithstanding, real supply is flat: at $879 billion, outstandings in the S&P/LSTA Leveraged Loan Index are down $1.5 billion from the beginning of the year.

With this excess investor demand, terms continue to favor issuers – and repricings and structural pressures have continued into February. TR-LPC noted (and graphed) the fact that first lien yields have contracted much further than second lien yields. Case in point(s): In the past year, first lien loan coupons have dropped more than 200 bps (to 4.46%, a 13-year low), while second lien loan coupons are down just 62 bps to 10.16%.  But now it may be time for the seconds to reprice, LCD wrote; 64% of the 118 second lien loans in the S&P/LSTA Leveraged Loan Index have seen their call protection lapse, leaving them free to refi.

Of course, lower spreads are not the only concession that issuers are seeking. According to LevFinInsights/CovenantReview, facing strong demand, issuers have made more liberal use of EBITDA adjustments in the past three months than they have in recent quarters. The average adjustments represented 29% of EBITDA for M&A transactions between December and February, up from 22% in the fourth quarter.

Clearly, lenders are ready to lend. Now the market just needs borrowers seeking real new credit for expansion.

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