The syndicated loan market is undergoing profound change. The result should be the emergence of a more liquid, price-efficient and competitive market - one which will benefit borrowers, banks and investors alike, says David Chandler.
The syndicated loan market in Europe, the Middle East and Africa
has accelerated its transformation this year from a closed,
price-inefficient, bank-only financing market, to a liquid,
price-efficient market financed increasingly by institutional
The single biggest driver of this fundamental change has been the continuing development and growth of the secondary loan market, which has brought liquidity to loan portfolios, enabling active portfolio management and thereby attracting institutional investors.
The increased activity in the secondary loan market ensures that the syndicated loan market will be liquid and competitive.
It is the work of the Loan Market Association in developing a more transparent and efficient mechanism for trading loans that has been the catalyst in bringing about the development and growth of the secondary loan market, which in turn has been critical in focusing the attention of institutional investors on the loan market.
As a result, we are seeing secondary market capability being enhanced by banks to take advantage of what is now perceived as a rapidly developing, orderly and professional market.
Investors not traditionally involved in the loan market are being actively courted by more and more banks, particularly those institutional investors who have traditionally operated in the fixed income and equity markets, and this is encouraging even further the development of the secondary market's investor base.
The secondary loan market is now evolving into a mature home for investment funds. The result of this change is that the primary market is increasingly treated as a mainstream asset class by a broad range of institutional investors, including hedge funds, insurance companies, pension funds, securitisation vehicles, derivative structures and prime rate funds, who are now able to start treating investment in loans as part of their value-based asset allocation strategy.
Indeed, it is interesting to note that in the US last year, institutional investors eclipsed foreign banks as the largest discrete retail market for highly leveraged loans.
By attracting institutional investors to the loan product, the syndicated loan market is able to ensure its competitiveness, despite the reduced lending capacity in the banking sector resulting from the ever-increasing consolidation of banks, and the current demise of participations from Asian banks.
Banks are building new relationships with these new investors, seeking ways to make deals attractive to them and beginning to approach the loan business in a similar way to bond distribution.
Banks are increasingly creating links between their loan teams and high yield bond desks, as well as with other fixed income distribution teams. This cross-fertilisation of techniques, ideas and experience will shape the way in which loans are originated, executed and distributed.
The ability to create these links will be one of the biggest challenges facing syndicated loan teams, for the recognition of the growing importance of institutional investors is now changing for ever the way the syndicated loan market is priced, structured and syndicated.
As institutional investors' share of the capital pool grows, they will play an even more influential role in the development of the loan market. For instance, the growing institutional investor base has prompted arrangers to more easily match borrowers' cashflow limitations and thereby ease the aggressive amortisation requirements of traditional bank term loans.
This has enabled borrowers to issue 'B', 'C' and 'D' loans with differing amortisation and maturity schedules, structured and targeted specifically at such institutional investors, alongside an 'A' loan structured on traditional lines for bank participations.
The ability to structure such deals and market them to potential institutional investors requires a whole new set of skills, which the co-operation and linkage between distribution teams will help to foster.
Again, to make loans even more attractive for banks and institutional investors, we are increasingly seeing some of the larger syndicated loans becoming freely tradeable, without having to obtain the consent of the borrower. This ability has enabled banks and institutional investors to reduce their credit spread requirement as a trade-off for increased liquidity.
This investor-led approach is also leading us to the position developing in the US, moving away from the traditional price-setting by the arranger as the system of setting prices for loans, with banks joining the transaction with that price in mind, to the system of setting prices that is used in the bond market - undertaking a bookbuilding exercise, and then structuring the loan (including the price) accordingly.
With the development of the secondary market we are now also witnessing the rise of the 'grey market' during primary syndication, giving rise to the potential of selling participations to investors in the secondary market before primary syndication has closed.
Over the coming months the grey market will cause great debate between loan arrangers, with arguments for (it happens in other markets) and arguments against (it leads to a disorderly primary market syndication).
This area of secondary market trading is being reviewed by the LMA as part of its role of preparing guidelines governing the secondary market. It looks as though the grey market is here to stay and this too will encourage the bookbuilding exercise seen in the bond markets.
One further area of development to touch upon is the role of the Internet in the primary and secondary markets. These days the Internet is pervading more and more aspects of financial life, and the syndicated loan market is proving no exception.
In the past, security restricted the speed at which new technologies were adopted, yet today, with rapidly advancing encryption and other security protocols, an increasing number of banks in the US have used the Internet, allowing them to bring complex and plain vanilla syndicated loans to market at high speed and at significantly reduced cost.
The ability to place an information memorandum and loan documentation on a secure website, so that participating banks can access and download relevant information, can secure faster credit committee approvals.
Not having to print, bind and courier information will also be a tremendous time saver, as well as a significant cost saver.
In many ways, it is also a more secure method than any we have had to date.
To date, the US is leading the way in Internet syndications, for deals of all sizes, and with its obvious benefits for the secondary market and for agency functions as well, should develop rapidly here as well.
The changes affecting the loan market have been dramatic, but they are by no means over.
Recent developments have been for the good, making the market more efficient and responsive.
New investors are getting involved, bringing fresh ideas, technologies and techniques, the advantages of which can be shared by all. The coming months will be challenging, but the loan market has always thrived on challenge. EW
David Chandler is head of loan syndications for Europe, Middle East and Africa at Bank of America and chairman of the Loan Syndication Club.