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| Mark Hughes |
Canadian banks are laying the groundwork for the development of secondary trading of Canadian loans and the introduction of non-bank buyers into the Canadian loan market. If successful, the Canadian market could emulate the explosive development of the U.S. loan arena. The banks have agreed upon a standardization of certain agreement provisions in loans to Canadian companies that will benefit banks, issuers and investors, explained Mark Hughes, head of global credit for RBC Capital Markets. The market is also committing to increased transparency and mark-to-market practice. "Banks will benefit from a portfolio management perspective as these provisions should make loan assets more liquid and easier to distribute to a wider universe of investors," said Hughes. "More importantly, standardizing certain loan provisions that enable the development of a secondary loan trading market will also be a benefit to borrowers, as there will be greater transparency of terms, banks may be willing to underwrite larger amounts as they will have additional means to distribute loans and innovations in loan structures are likely to be developed," he said.
For example, the U.S. market has been able to develop "B" loans and second-lien structures for issuers, which have been geared to meet non bank investors' differing risk and return requirements. This could also spur leveraged buyouts of Canadian companies, as the banks will be able to structure more easily the type of loans that fund these transactions.
A myriad of pension funds, hedge funds and insurance companies are interested in buying Canadian loans, Hughes said, noting in today's market there are many Canadian and U.S. non bank investors looking for new opportunities to place their money. He declined to name potential investors. U.S. loan participants agreed that once you create standardization and make it easier to trade, that supports the development of secondary liquidity, bringing in investors.
Pension plans such as the Ontario Municipal Employees Retirement System and The Ontario Teachers' pension plan, insurance companies such as Manulife Financial and hedge funds from the U.S. and Canada would be potential buyers, said sources.
The U.S. market turned to institutional buyers in the mid-'90s when funds filled a void left by the departure of Asian banks and a pullback in lending. Now non-bank investors such as collateralized loan obligations, floating-rate loan funds and hedge funds form the majority of the U.S. leveraged loan universe. But the Canadian market has not developed in the loan trading sense like the U.S., despite the fact the six main banks are all members of the Loan Syndication and Trading Association. "Canadian loan agreements have not benefited from standardized provisions such as assignment language and the differences between U.S. and Canadian agreements such as withholding tax provisions need to be taken into account," said Hughes.
He explained that the six main Canadian banks and three main foreign banks--J.P. Morgan, Bank One and HSBC--sat down and asked "Can we Canadianise the LSTA document? We are now going one step further and providing standardized provisions that will be attached to all new loan documentation. This is following the International ISDA approach of a standardized master agreement and then bolting on specific terms," he explained. Specific terms it standardizes will apply to the assignment of loans and the definition of an eligible assignee. This will go into effect Nov. 1 for all new loans and refinancings.
To begin with, this will result in the trading of only a portion of the Canadian lending market as investor's appetite for undrawn, investment-grade loans is limited. But about 100 loans are originated a year that would fall into this category, and once alternatives for issuers and investor's grow, this initiative will grow, Hughes explained.
