April 12, 2017 - There has been considerable discussion about the loosening of loan terms in the past year, but it’s not always easy to find specifics. On April 6th Tess Virmani (LSTA) moderated the Current State of the Syndicated Loan Market CLE at the ABA Business Law Section’s Spring Meeting in New Orleans, which offered these much needed specifics on deal term trends and recent legal developments in the large cap and middle markets. On the legal side she was joined by Portia Poindexter (Bank of America), Clifton Prabhu (HSBC) and Alex Spiro (PNC), as well as Ted Basta (LSTA) and Glenn Stewart (SunTrust) who offered the business perspective.
An overarching theme was the impact of the election on the loan market both in terms of volatility and, in conjunction with the Republican sweep in Congress, the potential for financial regulatory reform. After a positive reaction to the Trump administration at the start of the year, the tide may have turned as questions have arisen as to how many of his campaign promises, like tax reform, are achievable. In March, we saw both the US Dollar and the price of oil pull back from their earlier highs in 2017. Likewise, the equity markets has begun to give back some of their gains. With respect to regulatory reform, the table seems set for change with Republican majorities in both houses of Congress and a President who supports reform. It is important to remember, however, that change is a process. The panel highlighted the Leveraged Lending Guidance as an example that is ripe for change. On the one hand, each of the banking regulators will be under new leadership in the coming year, which could mean at a minimum a change in enforcement priorities or perhaps even explicit change. On the other hand, the staff at the regulatory agencies do not seem incentivized to change course. (Note, however, the possible game changer in the form of the Senator Toomey Leveraged Lending Guidance letter.) Assuming a regulatory status quo, the panel posited that the growth of direct lenders was set to continue, especially in the middle market where deal sizes are easily managed by one or two lenders.
Delving into deal terms, the panel set the stage with a close look at current loan market dynamics. Loan market technicals have been driven by excess demand for the past 12 months. As secondary prices have rallied, with 68% of loans bid at or above par in February, the market has seen refinancing activity surge to a record 78% of primary market issuance. At the same time, new issue institutional loan yields fell to 4.6%, down from 7% a year ago. The limited net new institutional loan supply also continued to support dividend recap deals, with $24 billion of volume in 2016, according to Thomson Reuters LPC. Those same dynamics have accounted for the dominance of downward price flex activity (YTD ratio of downward to upward flex stands at 9:1) and the flex terms borrowers were requesting in 2016. These include, short sunset periods on MFN provisions for incremental facilities, exceptions to the soft call premium and asset sale stepdowns tied to leveraged tests. The definition of EBITDA and what adjustments will be included remains a big negotiation point, with lenders requesting a cap on pro forma cost savings (the cap may also be subject to flex). Moving deeper into the document we see a continuing trend of borrowers wanting more flexibility to take actions without having to consult the lender group. This is unsurprising when covenant-lite loans make up 70% of total outstanding loans and additional flexibility, particularly around the incurrence of additional debt, is a key characteristic. The panel noted that middle market borrowers are also pushing for covenant-lite loans and this is a key area of negotiation on these deals. Incremental loan facilities are largely customary in the large cap space and are becoming more prevalent in middle market deals. The points of negotiation seen in 2016 include the size and nature of the free and clear basket, the trigger for the MFN provision, and automatic reclassification of transactions achieved under the free and clear basket as being achieved through the leverage-based test once financial condition has improved.
A final trend discussed was the growth of unitranche financings, both in size and prevalence. The panel noted the first $1 billion unitranche financing was completed in 2016 and discussed the increasing complexity of Agreement Among Lenders, particularly in the middle market. Complicated waterfall provisions and carefully drafted provisions regarding buy-out rights and voting rights are frequently observed.
The conversation continued on April 7th with a presentation by Andrew Fayé and Jane Summers, partners at Latham & Watkins, comparing terms in direct lending deals and broadly syndicated lending at the ABA Syndications and Lender Relations Subcommittee meeting hosted by Chair Maria Barclay (Practical Law Finance) and Vice-Chair Tess Virmani (LSTA).