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The loan market is reviving, but there are curbs on its growth.
Vincent Ryan, CFO.com | US
May 18, 2010
The "Deals Wanted" sign is back on the door of the institutional loan market for companies and private-equity sponsors seeking large amounts of capital. A report last week from Standard & Poor's Leveraged Commentary and Data showed new institutional loan issuance hit $19.2 billion in April, up from $14.2 billion in March and the most since October 2007.
In addition, as institutional investors have become comfortable again with corporate debt, the S&P/Loan Syndications and Trading Association Index — representing about 95% of the institutional market for U.S. bank debt — has climbed. The average price of a loan on the index is 91.57, up from December 2008's 60-plus range.
"[The market] has become much more issuer friendly in the last six months," says Steve Miller, managing director of S&P LCD. "Spreads are still wide compared to historical levels, but clearly a lot of [issuers] are jumping in because they feel it's a good time to refinance, take dividends out, or finance an acquisition."
"The loan market has rallied significantly," adds Seth Katzenstein, senior managing director of GSC Group, an alternative fixed-income manager.
Retail investors have brought the loan market back to life by pouring money into loan-participation mutual funds, which invest in floating-rate corporate borrowings. Inflows hit a record $1.4 billion during April. The inflows should continue, says Miller, for three reasons: loan funds have produced decent returns during the past 12 months (they are yielding 3% to 5% currently); the funds are floating rate, offering a good hedge against higher short-term interest rates; and the yields on alternative instruments, like short-term CDs, are "painfully low."
Loan repayments are also stimulating demand. In April companies paid down $12 billion in institutional loans, and year to date $44 billion has been repaid. "If [investors] get that money back in a managed account, they have to reinvest it in the asset class," explains Miller.
Still, money flows into the loan market pale in comparison with a few years ago, because the creation of new collateralized loan obligations, the vehicles that issue debt securities backed by a pool of commercial loans, is at a standstill. At their peak in 2006, CLOs supplied $97 billion of annual corporate loan appetite.
Also holding down the market's size is the inability of some asset managers to get the math to work. "Leveraged loans historically have been purchased by collateral managers that have employed leverage, but today collateral managers don't have access to leverage," Katzenstein says. "Spreads look attractive on an absolute basis, but relative to the current cost of capital they may not be attractive."
Loan buyers are making distinctions on a deal's leverage and structure, says Katzenstein. "For a straightforward deal there could be overwhelming demand," he says, "but for more-complex deals there aren't a significant number of buyers. In general there is not a lot of depth to the market right now — investors can be scared easily."
One potential danger is the hiccup in sovereign credit. "The loan market is responsive to things that go on in the broader market," says Miller. "If this PIIGS [Portugal, Italy, Ireland, Greece, and Spain] thing spirals out of control, that will have an impact."
Longer term, new financial regulations could also curb activity. "Risk retention" regulations in pending legislation could actually reduce the number of lenders with the capacity to issue and participate in syndicated loans, wrote three attorneys from Winston & Strawn LLP in an American Banker editorial last Wednesday. Bills in both the House and Senate would require securitizers and orginators of loans to retain, on an unhedged basis, 5% of the credit risk associated with a loan. A 5% risk-retention minimum could deter the creation of new CLOs, because CLOs and sponsors typically invest very little equity in a deal.
Some analysts say the retention requirement is unnecessary for the loan market. "CLOs have been unduly tainted by the broad brush of structured finance," said CreditSights analyst Chris Taggert in a recent report. "Unlike other forms of structured product, the senior and mezzanine tranches of cash flow CLOs maintained an ample subordination cushion through the credit crunch."