A crackdown on risky corporate lending by U.S. regulators is doing too little to shake up Wall Street, where the biggest banks are proving to have a hammerlock on the market for underwriting leveraged loans.
The same top five banks have arranged about 47 percent of U.S. junk loans sold this year to institutional investors, comparable to their share in all of 2013, according to data compiled by Bloomberg. Credit Suisse Group AG has supplanted Bank of America Corp. as the biggest underwriter, rising from No. 3, while JPMorgan Chase & Co. fell one spot to third.
While the Federal Reserve and Office of the Comptroller of the Currency have since last year expressed concern that lending standards are deteriorating, leveraged-loan issuance has still managed to top $303 billion this year, the third-biggest first half on record. Debt stripped of protections for lenders is being raised for private-equity firms seeking to buy companies including Gates Global Inc.
“The overall tone in the market is great and for us it has been a good year,” Jeff Cohen, the head of U.S. loan capital markets for Credit Suisse in New York, said in a phone interview. “We want to be the No. 1 bank that both the private-equity community and the loan investor community look to for interesting transactions.”
The banking industry has collected about $5.5 billion of fees from syndicated leveraged lending this year through June 16, following a record $14.3 billion in all of 2013, according to boutique investment bank Keefe, Bruyette & Woods Inc.
Loan issuance is falling short of last year’s record $414 billion in the first six months after investors began pulling money from loan funds in April, snapping an unprecedented 95 straight weeks of inflows. Banks last year arranged a record $695 billion of U.S. loans sold to institutional investors such as mutual funds and collateralized loan obligations, according to data compiled by Bloomberg.
“We had a minor correction in the loan market,” Gerry Murray, head of JPMorgan’s North America leveraged finance business, said in a phone interview. “There’s still plenty of capacity and deals are getting done with very attractive terms.”
About half of U.S. institutional loans issued this year are covenant-light, meaning they lack standard protections for lenders such as limits on debt relative to earnings, Bloomberg data show. A record $313 billion of the debt was arranged in 2013.
Borrowing costs in the loan market have fallen. The interest rate on institutional loans averaged 3.96 percentage points more than lending benchmarks on June 19, down from an 11-month high of 4.39 percentage points in May, according to Standard & Poor’s Capital IQ Leveraged Commentary & Data.
Given demand from investors, companies can raise more than $30 billion of speculative-grade debt to finance a large acquisition, including more than $15 billion of loans, Murray said.
Valeant Pharmaceuticals International Inc. said in a regulatory filing last week that it had commitments from banks including Barclays Plc, Royal Bank of Canada and Deutsche Bank AG to arrange a $12 billion junk-bond offering and another $7 billion in term loans to help fund its attempted takeover of Botox maker Allergan Inc.
The bull market for loans has continued after the Fed, OCC and Federal Deposit Insurance Corp. in March 2013 updated leveraged-lending guidance, saying debt levels of more than six times earnings before interest, taxes, depreciation and amortization “raises concerns.” Underwriting should also consider a borrower’s ability to pay down debt to a sustainable level within a “reasonable period,” they said.
Fed Chair Janet Yellen said at a press conference in Washington last week that the U.S. central bank is “using supervisory tools and regulations, both to make the financial system more robust and to pay particular attention to areas where we’ve spotted concerns, like leveraged lending.”
Speculative-grade loans have returned 2.3 percent this year, compared with 5 percent in all of 2013, according to the S&P/LSTA U.S. Leveraged Loan 100 index. The debt has returned about 99 percent since the end of 2008, the year Lehman Brothers Holdings Inc. collapsed, the index shows.
Leveraged loans are underperforming U.S. junk bonds, which have returned 5.7 percent this year after gaining 7.4 percent in 2013, according to Bank of America Merrill Lynch index data.
There may be more of a “crackdown” by regulators during the second half of this year, Brian Kleinhanzl, an analyst with KBW in New York, said in a telephone interview. Todd Vermilyea, a Fed regulator, said in May that standards “have continued to deteriorate in 2014” and that “stronger supervisory action” may be needed.
“In the initial guidance there was a lot of wiggle room for banks to interpret in many different ways,” Kleinhanzl said. “The earnings impact seems to be muted.”
While fees from leveraged lending represent less than 1 percent of total revenue for most banks, the business is tied to fees in other areas, he said. Banks also earn fees from private-equity firms for giving them advice on takeovers and taking companies they own public.
“You’re not going into leverage lending just because you want to go into leveraged lending, you’re into it for a greater share of the wallet,” Brad Hintz, an analyst at Sanford C. Bernstein & Co. said in a phone interview.
Credit Suisse, which has captured a 10.1 percent share of the institutional market, led about $2.8 billion of loans this month to help finance Blackstone Group LP’s $5.4 billion purchase of Gates Global, an industrial-products maker based in Denver, from Onex Corp. and Canada Pension Plan Investment Board, Bloomberg data show.
Gates’s buyout financing, which also included bonds, was marketed to investors with total leverage exceeding regulators’ guidelines. The deal was marketed with leverage of about 6.6 times Ebitda, according to a person with knowledge of the financing, who asked not to be identified, citing lack of authorization to speak publicly.
“For each of the transactions we participated in this year, the issuers demonstrated a clear ability, based on reasonable projections, to amortize more than half their debt during a five to seven year period,” Credit Suisse’s Cohen said.
Under the lending guidelines, a company should be able to pay down 100 percent of its senior secured loans and 50 percent of total debt within seven years, he said.
In the U.S. institutional market, Bank of America ranks second and JPMorgan is third. Deutsche Bank has risen to fourth and Barclays is now fifth largest based on market share, the data show. That market excludes revolvers and term loan As, typically held by banks.
Zia Ahmed, a spokesman for Bank of America; Brandon Ashcraft, a spokesman for Barclays; and Kerrie McHugh of Deutsche Bank all declined to comment.
The outflows from loan mutual funds this year have been mitigated by newly formed CLOs, which are the biggest buyers of leveraged loans and whose pace of issuance has accelerated.
Individual investors have deposited this year a net $2.1 billion in funds that buy U.S. leverage loans, compared with a record $62.9 billion in all of 2013, according to Lipper. Investors yanked $369 million in the week ended June 18.
CLO issuance has reached about $57 billion this year and may climb to as much as $100 billion in all of 2014, compared with a record $101.1 billion in 2007, according to Wells Fargo & Co. The pools, which fueled the leveraged buyout boom in 2005-2007, raised about $83 billion last year.
“You’re starting to see the pendulum to swing back” in favor of the borrower, William Hughes, the head of Citigroup Inc.’s U.S. loan syndicate, said in a telephone interview. The New York-based bank is the seventh-largest underwriter of U.S. institutional leveraged loans, with a 6.7 percent share, data compiled by Bloomberg show.