November 2017

Be a change agent! This was the LSTA’s call to loan agents at its recent annual gathering in New York

The Loan Syndications and Trading Association, comprised of over 400 member institutions, highlighted three market developments in the last few years: record highs for institutional lending in the primary market, the growth of the syndicated loans market in the US and the comeback of the CLO market despite the risk retention rules. But more can be done. Settlement hasn’t seen sufficient improvement and the documentation can change to become more efficient. The loan agency functions need more resources. CUSIPs should be universal, settlement cycles should be shorter and the industry needs to strike a balance between the flexibility that borrowers and investors value vs. standardisation to speed up settlement. All of this should support the growth of the loan market. It was here that the role of loan agents such as Deutsche Bank and their technology, systems and reporting tools to support such growth were lauded as agents of change.

The LSTA’s executive director Bram Smith set the scene in his welcome address: in addition to the need for better documentation to become more efficient, the industry needs smart contracts and a simpler language for loans and CLOs, a more fully automated payments landscape and new trading platforms. Changes debated were how the robotic revolution will change the market, how big data will change investment in a big way, and how blockchain will revolutionise lending. When polled, 49% of the audience said they believed that Distributed Ledger Technology, e.g. blockchain, would have the greatest impact on the loan market in the next five years.

Leaving libor

Naturally, the discontinuation of Libor as the global interest rate benchmark that is used across product classes, was discussed at the LSTA gathering. Amidst the uncertainty the industry can be sure that although Libor will potentially be replaced, the Fed’s monitoring authorities will have a transparent process to minimize the panic. The LSTA is also working on a comment letter and is coordinating responses among its working group.

Primary market: What’s new?

After the welcome address, a panel discussion turned its attention to institutional loan issuance, which has reached record levels in 2017 with an eye-catching $400 billion of “new” institutional loan issuance. However, many of these loans are straight refinancings (see figure 1) and even new loans are coming in with substantial refinancing repayment rates of between 30-70% as debt is given sparingly in the wake of new capital requirements and macro uncertainty. Where traditional loans have been critical for M&A, the industry is seeing more refinancings where corporates look to extend their balance sheets or reduce the cost of capital.  Net-net, new loan supply – measured as the change in the size of the S&P/LSTA Leveraged Loan Index – has only been $55 billion. This has been vastly overwhelmed by demand from CLOs, SMA’s and loan mutual funds.

Figure 1: A primary loan snapshot

source: LevFinInsights, S&P/LCD, TR-LPC (as shown at LSTA conference)
But the biggest problem in the primary markets is the lack of supply, in part because buying companies is so hard (LBO Purchase Price Multiples are at record highs), noted the LSTA. While supply has doubled in the last five years it is not enough.  Currently there is a $150 million gap between investor demand and supply (see figure 2).

Figure 2: Demand vs supply

source: S&P/LSTA Leveraged Loan Index, TR-LPC (as shown at LSTA conference)

Despite the increase in LBO activity, supply is low, leverage can’t (fully) follow and equity contributions are high. What is missing are the behemoth transactions with circa $15 billion in loans at once. There are two reasons for this: valuations are expensive and the days of overpaying are over. There are also more investment grade companies showing stronger balance sheets. 

In loan terms, the biggest issue is falling spreads, rising leverage, EBITDA adjustments but the biggest problem is loose documentation. According to an audience poll, these trends would be broken by either an exogenous shock (34%) or an unexpected default surge (25%) but frankly, participants of the primary market panel discussion said, the status quo – excess demand, softening structures, falling spreads – probably prevails for the next 12 months including geopolitical risk (like North Korea). Going forward, the issue should remain one of volume. With no new supply there will be a higher percentage of refinancing expected, particularly in 2018.

The biggest change in five years has been heightened activity for CLOs and mutual funds and a more sophisticated buyer and diverse retail investor base, delegates heard.

Middle market growth

The middle market has grown - annualized for the full year overall middle market syndicated volume has grown $151.1 billion between Q1 and Q3 of 2017 compared to $202.1 billion in 2014. Maturing between now and 2023 are some $238 billion of middle market sponsored syndicated loans, peaking at over $14 billion by the second quarter of 2021.

The documentation and loan agents were urged to be agents of change in moving the market forward. Those back office administrative agent roles and services provided to managers in the middle market are vital as this market sees further growth. For example, Deutsche Bank’s technology systems and reporting for loans has adapted to changes by providing third party loan agency servicing tools for arrangers in the syndications and middle market for loans. On the loan agency side Report Manager gives arrangers and lenders in the syndicated loan market real time loan information and reports about their portfolio whenever they want, regardless of their physical location. On the CLO/Trustee side Deal Manager provides a similar reporting tool, aiding the CLO manager by providing real time portfolio loan data.

A second coming for CLOs?

Meanwhile the secondary market has seen more activity with CLO issuance ($90bn) already surpassing FY2016 ($73bn), and visible new demand outpacing net new institutional loan supply by $41 billion (see figure 3). The secondary loan market has traded in a tight range in 2017, following 2016’s recovery period. This once booming market, which set an all-time record for issuance for a single year in 2014, saw a decrease in deal making in 2015, pressured by intense volatility that challenged financial markets broadly.

Figure 3: CLOs on the up

source: Thomson Reuters LPC & S&P/ LSTA Leveraged Loan Index

The past 18 months have been technology driven with the index at record levels particularly for institutional loans. The S&P/ LSTA leverage and index total return is slightly below “coupon” level, the retail sector total return is negative 2.1%. While total returns are positive on the year at 3.4%, market value returns are slightly negative (-0.37%).


But CLO issuances have a way to go before they get back to pre-2014 levels, delegates heard. Risk retention rules require managers or agents of those funds to invest up to 5% of capital in them. But instead of deterring managers from these funds, the rules could also support CLO creation. Alex Cormas, Structured Credit and Bank Loan Services Sales Manager, Trust & Agency Services, Deutsche Bank pointed out that “since the introduction of the rules in December 2016, managers have experimented with different compliant structures for their CLOs - the manager-owned affiliate (MOA), the capital manager vehicle (CMV), or the hybrid capitalised manager owned affiliate - to see what works best.

Par settlement times for this asset class have also trended higher and much of the industry’s growth will likely hinge on technology: “The loan market has not been as technologically advanced as other equity type products, it has traditionally been a struggle for managers to get a real time view of their portfolio,” said Melissa Sadler, Bank Loan Services manager in the Trust & Agency Services team at Deutsche Bank. “To help these managers meet the new requirements, Deutsche Bank’s loan administration platform makes it easier for a loan investor and/or arranger to get real time information about their portfolio whenever they want, again, regardless of their physical location. Since 1998 we have been adjusting our 3rd party loan product offering with the loan market by listening to what our clients want from a reporting and servicing perspective and being able to deliver accordingly.”

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