November 8, 2016 - November 8, 2016 – On November 3rd, roughly 1,000 market participants joined us at the LSTA’s 21st Annual Conference. For folks unable to attend, we offer some key takeaways below – and note that the slides are available on the LSTA website.
LSTA Chairman Dave Frey and Executive Director Bram Smith kicked off the day. Mr. Smith noted that we are at a tipping point with respect to loan settlement; hopefully efforts today will pay off in spades in the coming years. Mr. Frey amplified the call for change, telling everyone in the audience that “you are the LSTA” and that if you want change, you should help effect it.
After that clarion call, attention shifted to the political and economic sphere. The keynote featured a timely election analysis by political glitterati Ron Brownstein and Charlie Cook. First, their predictions: Both believed Clinton will win, the Republicans will hold the House and control of the Senate is a toss-up. They also highlighted the implications of a huge divide between the parties along a number of fronts. Republicans are far ahead among blue collar white voters and anyone outside urban areas; Democrats dominate white college graduates (especially women), blacks and Hispanics, Millennials and urbanites. And, regardless of the outcome, both noted that governing a country so starkly divided would be extraordinarily challenging for the next president.
Economist Michelle Meyer pondered what a Clinton or Trump presidency would mean for the markets. Her probable case of Clinton winning but not controlling Congress would suggest more gridlock; however there also is a possibility of corporate tax reform – including repatriation of cash trapped overseas – combined with a moderate infrastructure stimulus package. If Trump wins, predictions are harder to make. He does have the unilateral ability to drop out of trade treaties like NAFTA, which could slow the base US GDP growth rate below the predicted 1.8%. That said, he has a better chance cutting taxes than Clinton has in raising them.
Moving from political economy to markets, the kick-off primary panel noted that extremely strong demand – particularly from Asian investors facing negative returns at home – has swamped negligible net supply this year. The result is tumbling all-in TLB spreads – down 200 bps this year! – and loosening structure. This may continue: When polled, the audience and panelists were most concerned about strong technicals leading to weakening fundamentals and deal structures. For next year? More of the same: A plurality of voters expected similar issuance and flat outstandings.
The secondary panel continued the theme of technicals and fundamentals. The recent surge in demand, particularly from SMAs, coupled with a weak new issue market, has created a price floor in the secondary and therefore returns should be at least “coupon” for the remainder of this year and into next year. Panelists also were bullish on fundamentals, expecting defaults to be range bound and concentrated as downgrades slow. Finally, despite the lower turnover ratio, they agreed that liquidity actually has been quite good.
The afternoon market panels continued to document strong investor demand, albeit in different ways. CLO panelists noted Asian investors need positive returns and thus are absorbing the flurry of pre-risk retention deals hitting the market now – $16 billion in just September and October. If CLO formation remains in the $60 billion context next year, as anticipated, this could drive continued strong demand for loan assets.
While CLO formation is keeping the BSL market hot, similar trends can be observed in the middle market, as that eponymous panel explained. While midmarket arrangers typically hold large stakes – and therefore are aligned with their investors – the middle market still is seeing erosion as sponsors and lawyers familiar with large corporate trends move down market. In particular, middle market investors are concerned about EBITDA adjustments as these feed into other loose terms in documents, such as restricted payments and additional debt.
So how are said lawyers and sponsors negotiating docs? The “Terms and Trends” panelists commented that, while it is a common perception that less is being negotiated as the market has moved to using sponsor precedent, that is not exactly the case. Rather, negotiations are being front-loaded to the commitment paper stage so that little is left to negotiate at the time of drafting the credit agreement.
Another theme making its way into numerous panels is the rise of direct lenders. Terms and Trenders noted that sponsors are looking for speed and certainty – and with the current regulatory constraints in banks, direct lenders are becoming an important capital provider. While direct lenders are currently constrained by smaller balance sheets, Middle Marketers said they were fundraising rapidly and that there could be as much as $100 billion (including leverage) available soon.
While no market panelists forecast a spike in defaults or bankruptcies, the space nevertheless bears watching. And so, the bankruptcy panel flagged three trending issues. The Supreme Court will soon weigh in on whether structured dismissals are permitted and the panel agreed that while a purist might argue (and the SCOTUS may decide) that they are not permissible, the practitioner values the flexibility they provide in resolving difficult cases. Panelists also noted that after a long absence, equity committees are coming back, especially in oil and gas cases. Finally, the panel described how courts are construing turnover provisions in intercreditor agreements extremely narrowly against secured creditors and advised the audience to exercise great care in drafting these agreements.
Unfamiliar with the drafting notes flagged by the Terms and Trenders or intercreditor issues highlighted by the Bankruptcy specialists? Then perhaps the LSTA Complete Credit Agreement Guide is for you! At the conference last week, the authors recapped the book’s main points and shared their insights on key negotiation points loan market participants may encounter; they also flagged the new LSTA model credit agreement provisions and LSTA regulatory guidance which have been incorporated in the second edition. The authors highlighted some of the new technology included in complex agreements since the first edition was written, driven largely by increased regulatory scrutiny, the continuing globalization of the loan market, and the demand by borrowers for more flexibility. So what will influence the next edition? When polled, the majority of the audience said further convergence with bond technology was likely to have the biggest impact on credit agreement structures in ten years’ time.
The day ended as it began: With a plea for market help on settlement. The Operations panel determined that, despite initial concerns, the new delayed comp regime has gotten off to an impressive start with buyers and sellers, on average, meeting the Phase I requirements by T+2.7 and T+5.3. Preliminary stats are positive: 86% of September trades settled with only 2% forfeiting compensation. 50% more trades settled by T+7, compared with those under the prior delayed comp standard. However, with a median of T+9 settlement time, challenges still seem to reside with the agent banks. The other takeaway? Everyone must work to effect the change needed to reach T+7.