January 14, 2016 / 5:43 PM / in 2 years

Update 1: Citi to add new tranche to US$2.5bn Petco buyout loan with no Libor floor

NEW YORK, Jan 14 (Reuters) - Citigroup is adding a new tranche to the US$2.5bn loan backing the buyout of Petco Animal Supplies that will not have a Libor floor, as rising interest rates threaten returns to Collateralized Loan Obligation (CLO) funds, the main buyers of leveraged loans.

At least one large investor requested the change for the financing backing the purchase of the pet supplier by private-equity firms CVC Capital Partners and Canada Pension Plan Investment Board (CPPIB), sources said.

Libor floors guarantee minimum returns for loan investors, but are threatening returns to holders of the riskiest CLO slices as Libor rises.

CLOs pool leveraged loans, which are used to back buyouts, that pay the fund a set spread over Libor. Separately, these vehicles sell slices of varying seniority to investors such as insurance companies. Due to the floor on the benchmark, the interest paid to the fund does not change even when Libor rises. Because CLO tranches do not have Libor floors, the interest it must pay to its investors increases, eating up the excess spread that otherwise would have been distributed to holders of the riskiest piece of the fund, the equity slice.

The new portion of the Petco loan may be around US$500m in size, depending on demand. It will be offered with a rate of 500bp and a discount of 98 cents on the dollar, the source said.

The term loan currently being marketed with a Libor floor will now pay 475bp with a 1% floor at 98 cents. It was originally offered with a spread of 450bp with a 1% floor and a discount in the 98.5-99 range.

The total size of the term loan will remain at US$2.5bn and be adjusted based on demand for the tranche without the floor.

In addition, the 101 soft call protection on the loan was increased to 12 months from six months.

Commitments are due Thursday at 5 p.m. with allocations expected on Friday, the source said.

CLOs have benefited from Libor floors since the credit crisis when the feature helped to boost yields after three-month Libor fell from a 10-year high of 5.72% in September 2007 to below 1% in May 2009.

Three-month Libor, the benchmark loan spreads are based on, rose 91% to 62bp Wednesday from 32.4bp on October 1.

Ninety-eight percent of first-lien term loans issued in 2015 until the end of November included Libor floors, typically of 1% or 0.75%, according to Thomson Reuters LPC. (Editing by Tessa Walsh and Michelle Sierra)

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