Loan Ratings Increase with Institutional Buyers

As institutional investors continue to heighten their profile in the bank loan market, ratings, in turn, are becoming much more prevalent, a step that loan pros say is imperative as this sector evolves toward becoming like the rest of the capital markets.

According to a study last month by Portfolio Management Data, 70% of loans marketed to institutional investors in the first half of this year were rated, up from the 61% of institutional loans that were rated last year. And going forward, that number is expected to grow even further.

"A year from now we'll see more ratings than there are now," said Bob Healy, group managing director of loan syndications at First Union Corp. "You need to get a rating for [institutional investors] to really play in a deal."

Data provided by PMD show that of all the institutional loans rated by S&P so far this year, the majority are BB-minus, while more loans are in the double-B range than the single-B range. Market players note this is perfectly in line with the strategies of collateralized loan obligation funds, which are typically more interested in buying BB-rated loans.

To be sure, ratings aren't a requisite for every institutional buyer, a point that Healy and others acknowledged. And some market players question their impact given the fact that overall liquidity in the loan market is still shaky.

However, for many institutional investors - especially some of the new CLO funds - ratings are extremely important, as these buyers focus on secondary trading opportunities and, in many cases, have to meet certain rating criteria.

"Many of these institutional investors are interested in liquidity," said Bruce Ling, managing director and global head of syndicated finance at Credit Suisse First Boston. "The ratings add to this liquidity, creating a more attractive market."

Adds Steven Bavaria, director of bank loan ratings at Standard & Poor's Ratings Group: "It's further evidence that the syndicated loan market is becoming more efficient, and, indeed, a real securities market."

Filling The Void

While the augmented role of institutional players in this market is noteworthy - market pros say the number stands at 120 - it becomes even more interesting when considering the concurrent drop in activity by commercial banks.

In the past, commercial banks played the roles of both arranger and investor, often holding onto the loans they made. But these days, sell-siders say banks increasingly see themselves as facilitators, realizing that more profit can be made by syndicating the loans to other buyers, such as institutional investors.

"The banks are already going through a period of re-evaluation, assessing the capital they're putting in and the returns gotten from this business," says CSFB's Ling. "As a result, many banks are less aggressive. This has created a void in the market, which institutional investors coincidentally have been quick to fill."

Indeed, institutional buyers have been especially ambitious in the leveraged loan arena. While the yields on revolvers and A pieces generally don't attract non-banks, the fat spreads on leveraged transactions have proven to be too temping to pass up, especially when considering that leveraged loans have better recovery rates than high-yield bonds - a distinction widely referenced by bankers when the junk market languished in late 1998.

In the first half of this year alone, 219 out of 716 leveraged deals saw participation by institutional buyers, who collectively bought up nearly $40 billion worth of loans, or about 24% of the total volume. When it comes to leveraged buyout loans worth at least $100 million, the percentage increased to 42%, according to PMD.

"The end investor often times is a non-bank institution," says Robert Grossman, group managing director at Fitch IBCA. "These people like ratings."