May 10, 2018 - It’s official. The Fed (and senior loan officers) have spoken: Supply and demand are not balanced. The Fed’s 1Q18 Senior Loan Officer Opinion (SLOO) Survey was published on May 8th and identifies supply/demand dynamics and their impact on loan terms and conditions. First, large and middle market borrowers simply have lower demand for loans. As TR-LPC charted, nearly one-fifth of the SLOO bank respondents said borrower demand for loans was “moderately weaker”; in fourth quarter 2017, more banks said that borrower demand had strengthened.
Lender demand for loans, meanwhile, remains quite strong. In turn, loan terms and conditions loosened. A net 13% of large banks loosened their lending standards for large and middle market firms. (Net loosening is simply the percent of “tighteners” subtracted from the percent of “looseners”.) Of the looseners, a net 40% said they reduced spreads, net 11% said they eased premiums on riskier loans and net 18% said they eased loan covenants. Of course, the banks all did this because their competitors were doing the same: 62% of respondents said that “more aggressive competition” was a very important reason for loosening terms.
So, how do the SLOO stats compare to what we are seeing in the institutional loan market? On borrower demand, we’d note that real institutional loan supply actually is solid: outstandings in the S&P/LSTA Leveraged Loan Index have increased by more than $50 billion to $1.008 trillion so far in 2018. That said, the Index growth might reflect that stronger 4Q17 borrower loan demand coming to fruition.
For the terms and conditions, we were definitely seeing SLOO’s reported spread compression. According to LCD’s LoanStats Weekly, average spreads on BB/BB- TLBs (LIB+217) and B+/B TLBs (LIB+330) are near their post-crisis lows. However, as TR-LPC charted, because LIBOR is increasing quickly, actual loan “coupons” have been climbing.
One place we saw a disconnect between our market and the SLOO survey was that only a net 18% of bank respondents said they were loosening covenants. Based on our informal conversations with investors, everyone is loosening covenants. Indeed, despite falling spreads, continued repricings and shrinking subordination, we’d suggest that loosening loan covenants (and documentation) is the number one source of investor heartburn.