Theodore Basta, Elliott Ganz and Bridget Marsh of the Loan Syndications & Trading Association (LSTA) in New York dissect current trends in the US loan market. The panel looks at what the data is telling us about the market, what regulatory developments are uppermost on the agenda and what efforts the LSTA has recently been making in Latin America.
What is the general trajectory of activity in the US loan market this year?
Ted Basta (TB): In 2015, loan returns ran negative for only the second time in history (the other year being 2008, of course) and a lot of that had to do with specific sectors, most notably the oil and gas industry. In 2016, risk assets, including the energy sector, staged a dramatic turnaround as loan returns hit double digits while the secondary market rallied to multi-year highs (the median trade price has remained at or above par since September 2016). The market really started to turn around during the end of Q1 2016. From that point forward, macro conditions began to improve, while strong technicals were supported by robust demand. As a result, monthly loan returns were positive from March 2016 through May 2017 – although returns did go slightly negative in June due to a shift in technicals and then again in August as investors looked to shed risk in light of geopolitical concerns.
That said, when you couple robust demand levels with a pretty strong fundamental backdrop (default rates have trended well below their historical averages), it really sets the tone for the type of performance we have seen over the last twelve months (+ 6%) and should expect for the remainder of this year.
In reality, secondary market prices didn't have much runway left to move higher this year, and therefore most managers believed the secondary would trade mostly flat and returns would be right around coupon. And that is exactly what we have seen. Through mid-September, collateralised loan obligation (CLO) issuance has topped $70 billion, while loan mutual funds reported net inflows of about $20 billion. That totals roughly $90 billion of new demand entering the asset class, and that doesn't include the countless separately managed accounts (SMAs) that came on line this year. On the flipside, according to our S&P/LSTA Leveraged Loan Index, outstandings have increased by $50 billion this year to a record $930 billion. From a technical perspective, that leaves us with a noteworthy demand overhang of about $40 billion this year.
Furthermore, the only major sector in our asset class that has reported negative returns is retail, which is down a little over 2% so far, whereas the broader market has returned close to 3%. I think a lot of those same trends apply to the European market.
Would you characterise the loan market as buoyant in both the US and Europe?
TB: Absolutely. In both the US and Europe we have witnessed massive demand for the loan product and record-level loan issuance. But if you dig deeper into this year's numbers, about 70% of global new issue has been in terms of refinancing. This is because the majority of loans across both markets have been trading at par or higher in the secondary market for some time. As a result, new issue spreads have declined in both the US and European loan markets.
The big difference between the two markets today is in the base rates. Since year-end 2015, 3-mo Libor has increased to 132 basis points, following multiple rate hikes, whereas base rates are still negative in Europe – and the European Libor floors are minimal. That said, from a borrower's perspective, the European market certainly looks cheaper today. And just as important, liquidity is very robust in Europe right now, as non-traditional accounts (outside of CLOs) have looked to invest given the negative rate environment and the high valuation levels in the bond markets.
What does it mean that so much of the market is refinancing?
TB: At the end of the day when you see spread reductions from a lending standpoint, the markets are generally hot and things are going well. And while lenders will in fact receive a lower rate of return, the great thing about loans is that they are a floating rate asset class and loan spreads are pegged off Libor. Right now, Libor is at 132 basis points in the US; six months ago, it was below 100 basis points. So, while we are seeing spread reductions in one sense, we are also seeing increases in Libor, which have offset a portion of the spread reductions. But as refinancing has come in at record levels, net new deal flow has been slower than previously expected. You always want to see the asset class growing and while we have added about $50 billion in new money loans this year, I would say that one of the trends we have seen over the past year or so is lower M&A volume, and that is how you grow the industry for the most part – through M&A.
Have you a sense of how these trends are playing out in terms of cross-border activity?
TB: While I don't track cross-border activity as closely, I do know that total cross-border volumes are up roughly 35% year over year – and that trend was beginning to pick up steam in September as several larger M&A deals were in the process of completion. That said, the big takeaway for me in the cross-border space this year is that the market share of deals that were syndicated in Europe picked up to a 33% share from 25% last year. In dollar terms, cross-border deals syndicated in Europe increased 73% this year compared to an increase of just 23% for those syndicated in the US.
What are the biggest regulatory debates in the US?
Elliot Ganz (EG): Two touch points are worth mentioning. The first is in leveraged lending guidelines. In 2013 the US regulators put out the Leveraged Lending Guidelines, which set parameters for what the agencies (financial regulators) thought would be prudent underwriting of leveraged loans. They included, for example, the requirement that lenders needed to show that their leveraged borrowers would be able to pay back all their senior loans or half their total debt in five to seven years from free cash flow. Plus, anything over six times leveraged would be suspect and the agencies would take a close look. Interestingly, the European leveraged lending guidelines are very similar but in certain respects clearer.
On risk retention, the European guidelines first came out in 2011 and were quite strict, requiring 5% of the value of the securitisation to be retained. After a number of iterations and some regulatory scares, the market has readjusted, though issuance never really returned to pre-financial crisis levels. In the US, the final guidelines came out in late 2014 and went into effect late last year. The market has adjusted as well, mainly through raising third party capital and financing, which has resulted in fairly robust US issuance this year.
Is the Trump administration likely to produce significant changes regarding leveraged lending guidelines and risk retention rules?
EG: In a recent report issued by the Treasury Department, the US administration has questioned whether leveraged lending guidance has gone too far and has suggested to the agencies that they open up the guidelines for comments and consider giving more discretion back to the banks. Nothing concrete has yet been done but it is clearly an area the administration is following. We also understand that Treasury will soon be releasing another report that is likely to contain something about risk retention.
In both cases, it is important to note that the Treasury Department does not by itself have the ability to make anything concrete happen, but they can set the tone and put some pressure on the agencies to do something about it.
How has the LSTA's engagement in Latin American markets been developing?
Bridget Marsh (BM): The LSTA formally launched its Latin American Initiative in 2015, but research and preliminary thinking on the topic had been evolving for several years before that. Our goal is to develop products for both the primary market, where New York law governed loans to Latin American borrowers are originated, and the secondary market, where those loans are traded with a view to helping a liquid market further emerge and grow. Thus far, we have focused on three jurisdictions – Chile, Colombia and Peru – and have published credit agreement language suited for New York law governed loans made to borrowers in those regions. A few months ago, we published secondary trading documents which can be used to evidence the trading and settling of the sales of those loans.
Settling loan trades by participation is an approach that may be used more regularly in those jurisdictions than it is here, for many different reasons and so we also published a form of participation agreement as well. Next, we are looking at Mexico. We hope that this simplifies the steps and makes trading loans easier and quicker.
Where is the region heading? Like so many industries, the loan market is increasingly becoming a global market, and there is significant growth potential in LatAm. As that growth is poised to accelerate in different LatAm regions (some positive data from H1 2017 sees syndicated lending improving after a couple of rather quiet years), the LSTA hopes it can play a part in helping to put the necessary building blocks in place to enable that growth.
What sort of documentation structures are common in Latin America? We note in the US and Europe cov-lite structures and proliferating. Has there been an evolution in the players involved in the market?
BM: I cannot comment on the specific documentation terms, but more generally, it seems that certain regional banks are able to make loans entirely on their own without seeking the involvement of the large global banks; from what I understand, this is a post-global financial crisis development, which may be making it more competitive for US banks doing business in the region. It will be interesting to see how that progresses
|About the author|
Ted Basta is SVP of market analysis for the LSTA, where he manages key strategic partnerships and products, including the LSTA's trade and settlement data initiatives, the LSTA/Thomson Reuters LPC Pricing Service and the S&P/LSTA Leveraged Loan Index. In addition, Basta is responsible for the Association's analytical and reporting initiatives; all of which enhance market visibility, transparency and liquidity. Those efforts include the continued development, expansion and distribution of market analytics and secondary trading and settlement metrics. Basta also manages the LSTA's Shift Date Process, the Association's website and its social media initiatives.
Prior to joining the LSTA, Basta was director of global pricing with Loan Pricing Corporation (LPC), where he was instrumental in driving new product development and secondary market content. Basta received an MBA from the Zicklin School of Business at Baruch College and a BA in accounting from Long Island University.
|About the author|
Elliot Ganz is executive VP and general counsel of the LSTA. In that capacity, he manages all aspects of the LSTA's legal affairs and co-heads its government policy and advocacy committee.
Ganz received his JD in 1980 from the New York University School of Law where he served as research editor of the Annual Survey of American Law.
Ganz was the first chairman of the legal advisory committee of the LSTA and has served as a member of its board of directors. He was elected as a fellow of the American College of Commercial Finance Lawyers in April 2011, was admitted to the US Supreme Court bar in April 2012 and served as a member of the advisory committee on financing Chapter 11 for the American Bankruptcy Institute's Commission to Study the Reform of Chapter 11.
|About the author|
Bridget Marsh is executive VP and deputy general counsel of the LSTA. Marsh heads the LSTA's primary market committee and trade practices and forms committee and leads the legal projects for the development and standardisation of the LSTA's documentation. She is responsible for responding to and addressing secondary loan market trading disruptions and ensuring that the LSTA's primary market and trading documentation reflect current market practices.
Prior to joining the LSTA, Marsh practiced as a corporate finance attorney at Milbank, New York, and as a lawyer in the corporate/M&A department of Simmons & Simmons, London. Marsh received a BA magna cum laude from Georgetown University, a law degree with first class honours from Sydney Law School and a masters in political Science from the University of New South Wales. She is admitted as an attorney in New York, England & Wales, and New South Wales, Australia.
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