May/June 2011

Conversations From Villanova — A Loan Market Review of Q1/11

In early April, nearly 100 commercial finance, turnaround and bankruptcy professionals gathered at the Villanova University Conference Center in Villanova, PA to attend the Fourth Annual Education and Networking Event jointly sponsored by ABF Journal, the New York Institute of Credit and the Philadelphia Chapter of the Turnaround Management Association. Maria Dikeos, director of analytics for Thomson Reuters LPC, was on hand to moderate a panel focused on the lending environment. We thought it wise to share a portion of Dikeos’ presentation with a wider audience.

The loan market operated with both a lot of energy and appetite for much of the first-quarter 2011. Lender liquidity was robust and, while not exactly thrilling, the U.S. economy hinted at a nascent recovery. In fact, the only impediment to robust lending activity was a rather lackluster pipeline of deals — and to be more specific, new loan assets.

This trend gave rise to a supply demand dynamic, which was marked by greater competition among investors as well as credit terms and conditions that had all the hallmarks of an overheated market. By the end of the first week of March, however, the world was looking a bit different. The geopolitical events in North Africa and the Middle East did not reintroduce risk to the capital markets, but they did give the market pause.

In the high-yield bond market, although fund flows were net positive for the quarter at over $7 billion, in the second half of March, over $1 billion was pulled from funds (although $500 million in net purchases were made at the very end of the month).

In the loan market specifically, despite robust liquidity and a strong desire among investors to put money to work, there was already a growing sense among both issuers and investors that the opportunistic refinancings with razor-thin spreads, which had dominated lending activity in first quarter, were ripe for pushback. In fact, between March 10 and March 31, over $18 billion in anticipated loan issuance was pulled from the market as issuers postponed opportunistic refinancings. Nevertheless, funds continued to flow into the loan market, further highlighting a growing supply demand imbalance.

Figure One: Institutional Loans Exceed HY Bonds for First Time in Two Years

At $104 billion, total institutional loan volume represented the highest quarterly volume since Q2/07 and outpaced high-yield bond volume, which closed out the quarter at just under $81.5 billion

Figure Two: ABL Lending in the Context of Broader Leveraged Lending

Figure Three: At Over 27% Billion, Largest Quarterly Issuance of ABL, But Lending Activity Weighted Toward Refinancings

Figure Four: Fears Around Refinancing Cliff Abate, Focus on New Money Issuance Gains Momentum

Unsurprisingly and in line with the broader leveraged loan market, despite the fact that M&A activity represented 18% of total ABL issuance, in practice, this only translated to just over $4.6 billion of issuance.

Figure Five: Supply/Demand Imbalance Drives Spreads Down

At 72% of total lending activity, asset-based refinancing activity represented a complicated proposition for lenders. At the outset they provided opportunities for fees, but in practice, they also found themselves squeezed dramatically. With demand for assets far outpacing supply, issuers looked to trim costs wherever they could.

Structurally, spreads were trimmed as average spreads hovered just north of 250 bps over LIBOR (down from over 270 bps as of the end of last year). Up front fees came down and undrawn credits became a renewed cause for concern among lenders.

Figure Six: Five-Year Structures Re-Emerge Via Refis and Select M&A Opportunities

Additionally, five-year credits resurfaced in dramatic fashion to replace both three-year and four-year credits.

Ultimately, although the liquidity was there to be had and lenders kept busy, deal flow was qualified.