Loans, bonds and the line between them

Thanks to a lawsuit in the US, the question of whether leveraged loans are securities or not appears to be on the table. The challenge points to a gap in the regulation of modern capital markets that needs filling in.

  • By Owen Sanderson
  • 14 May 2019
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JP Morgan and a clutch of other banks are being sued over a loan to Millennium Health, as the banks in question allegedly failed to tell investors about a US Justice Department probe into the firm’s billing practices.

Leaving aside the particulars of the case, on which this newspaper makes no comment, in a bond issue that sort of thing might well count as a violation. Investors buying public securities expect all material facts to be made public; highly choreographed rules exist about when and what kinds of disclosures can be forced.

If you look at a bond document — pretty easy to do — there’s a good, long list of risk factors, much of which is well padded posterior covering.

Verisure, appropriately enough an alarm company, which printed a bond on Monday, flagged to investors the risk that “existing competitors may expand their current product and service offerings more rapidly, adapt to new or emerging technologies more quickly, take advantage of acquisitions or devote greater resources to the marketing and sale of their products and services, than we do. Our competitors may use lower pricing to increase their customer base and win market share.”

Is there a single company in any industry of which this statement would not be true?

Regardless, the posterior protection has its place – and the ever-present threat of legal liability keeps disclosures strong.

The banks on the Millennium deal, however, are arguing that the investors’ case should be dismissed, because the loans they bought are not securities. Again, GlobalCapital offers no comment on the particulars of the case but the general idea that leveraged loans are not securities seems obviously correct.

Loans don’t trade or clear like securities, they are not listed, they are different in legal form, they can be held by different legal entities, they are subject to different confidentiality and disclosure requirements, their standards for underwriting are different. It seems obvious, on the face of it, that the investors will fail in this test.

Where's the line?

But it ought to prompt some head scratching from regulators about whether the historic division between loans and bonds is still fit for purpose, as far as regulatory principles are concerned.

In GlobalCapital’s view, it is not. Where financial instruments are economically equivalent, their regulatory treatment ought to be as closely aligned as possible. Regulation should be concerned with substance, rather than form, and the substance of high yield bonds and broadly syndicated leveraged loans has become so close as to be almost indistinguishable in recent years.

Leveraged credit issuers and financial sponsors draw no real distinction between the products; neither do most investors, who invest across credit products, and neither do many banks, where origination and syndicate desks typically deal in both.

There are differences in tendency and tradition. High yield bonds give investors a period where issuers cannot call the notes, which pay a fixed rate. Loans usually pay a floating rate and offer no call protection. But the impassable mountain range that once existed between the security and covenant packages expected in each market — the really tangible economic terms, in other words — has been bulldozed.

Where to draw the line with regulations affects prices.

In the US, despite the eroding differences between products, collateralised loan obligations must only contain loans to avoid being caught by another set of regulatory obligations.That creates a captive pool of demand , which in turn affects pricing.

Similarly, in Europe, regulatory differences shape the buyer base. The Ucits directive determines which funds retail investors can buy — and virtually ensures that they are obliged to invest in securities, rather than loans or private products, creating a loan market which is almost entirely populated with institutional money.


But the regulatory difference between the products is based on assumptions that no longer hold.

Loans were traditionally extended by banks and held by them, while bonds were bought by fund managers or savers directly — conditions that are no longer true, with buy-side institutions forming the majority of the loan investor base in the US and Europe alike, and investment banks underwriting and distributing in similar manner whatever the product.

Advocates for the status quo often flag privacy concerns for borrowers, who may be unwilling to share their financial information with the market (and, implicitly, with competitors). Financial sponsors want to put the “private” in “private equity” and conceal the progress of their business.

But these concerns are self-serving.

If a company is large enough to raise hundreds of millions of dollars or euros from investors, it’s big enough to handle the burden of proper reporting, and big enough for society at large to have a legitimate interest in its operations. It’s proper that individuals have a right to privacy, but companies are not individuals.

In any case, combing financial reporting for competitive advantage can often be fruitless. Public companies are perfectly capable of informing their shareholders and creditors of their financial conditions while concealing much operational information — most of the underwriters of leveraged credit products are publicly traded, and you’ll be searching in vain for a risk position or P&L disclosure you can use.

Mid-market, bilateral or SME lending is a different matter. Smaller companies cannot be expected to reach disclosure standards required in public capital markets, though regulators in Europe are trying to tackle this from the other direction, promoting lighter touch regimes for these firms.

But these have little in common with the €100m and up, institutionally targeted loan product. Regulation can be burdensome, and welcoming more of it seems perverse. But it’s most burdensome when it no longer fits market practice.

  • By Owen Sanderson
  • 14 May 2019

All International Bonds

Rank Lead Manager Amount $b No of issues Share %
  • Last updated
  • Today
1 JPMorgan 327.88 1495 8.47%
2 Citi 300.87 1281 7.78%
3 Bank of America Merrill Lynch 257.92 1081 6.67%
4 Barclays 234.22 962 6.05%
5 HSBC 189.93 1042 4.91%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $b No of issues Share %
  • Last updated
  • Today
1 BNP Paribas 37.08 171 7.23%
2 Credit Agricole CIB 35.71 154 6.96%
3 JPMorgan 29.35 74 5.72%
4 Bank of America Merrill Lynch 24.21 68 4.72%
5 SG Corporate & Investment Banking 23.67 111 4.61%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $b No of issues Share %
  • Last updated
  • Today
1 JPMorgan 10.13 66 9.88%
2 Morgan Stanley 9.41 44 9.17%
3 Goldman Sachs 8.72 45 8.50%
4 Citi 6.74 52 6.57%
5 UBS 5.32 30 5.19%