Jun 10

Loan sales and growing role of institutional investors (academic paper)

by David Harper, CFA, FRM, CIPM

FRM Learning outcome: Describe two major segments of the loan sales market (but dropped from the 2008 AIMs)

Aside from the emerging-market, the U.S. loan sales market has two segments

Traditional short-term: Secured by assets of the borrowing firm; made to investment- grade borrowers; Issued for a short term (90 days or less); Yields near commercial paper rate (up to +10 bps); Sold in units of $1 million and up
Highly Leverage Transaction (HLT) loan sales. Defined as one the (1) involves a buyout, acquisition, or recapitalization and (2) doubles the company's liabilities and results in a leverage ratio higher than 50%, results in a leverage ratio higher than 75%, or is designated as an HLT by a syndication agent. Either non-distressed (bid price exceeds 95 cents per $1 of loans) or distressed (bid price is less than 95 cents per $1 of loans or the borrower is in default).

HLT loans are term loans, secured by borrowing firm's assets (usually senior secured), typically longer maturity (three- to six-year), floating rates (tied to LIBOR, prime rate, or a CD rate, normally +200 to +275 basis points above these rates), and they have strong covenant protection.

Trends in syndicated loans

Here is a fabulous primer on the difference between leveraged loans (i.e., a non-investment grade loan) and corporate bonds. Both are sources of external financing and the syndicated loan market "now competes directly with bond markets." Why are most of the syndicated loans that trade in secondary market leveraged? "1) primary arrangers of syndicated loans (the big universal banks) prefer to transfer lower quality credit risk off their books after originating and arranging the syndicated loan and earning the origination and arrangement fees from the transaction, and 2) the risks associated with sub-investment grade loans have concomitantly higher potential returns which are of greater interest to active buyers in the secondary market such as hedge funds, CDOs and distressed debt investors." â€“ Peter McAniff
Recent academic paper on on the growth of institutional investors (hedge funds, private equity funds)as players in syndicated loan markets (both primary and secondary). In regard to primary market, author finds "institutional investors almost exclusively fund leveraged loans, with credit rating BBB and below." Also compared to bank loans, they have greater spreads, "lend to riskier borrowers for riskier purposes," have more financial covenants, longer maturities, and "almost always secured." In regard to secondary market, "while on average 30% to 35% of institutional loans are traded, only 6% of commercial bank loans are traded on the secondary market. Moreover, the probability of an institutional loan being resold is on average 4 times more than that of a bank loan and the average holding period for an institutional loan is 3 times less than a bank loan, indicating that institutions are more active participants in the secondary market compared to commercial banks" (Debarshi Nandy and Pei Shao)