Middle Market Borrowers Encountering Volatility Similar to the Bond Markets, Says Morgan Joseph

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New Lenders Replacing Traditional Sources Amidst Reduced Loan Supply and Rising Rates, Prompting Changes in Post-Lehman World

NEW YORK--(BUSINESS WIRE)-- Amidst a reduced supply of loan capital and rising clearing rates, middle market borrowers now are increasingly dealing with more volatile market conditions akin to traditional bond markets, according to Morgan Joseph TriArtisan LLC. (“Morgan Joseph”).

In its latest Restructuring Quarterly Newsletter, the investment bank declared that “in a post-Lehman world, loan markets are day by day becoming less fueled by committed CLO (collateralized loan obligation) capital and more backed by retail, hedge fund, and other institutional investors common in the bond world.”

“In other words,” says James D. Decker, a Managing Director who heads up the firm’s Restructuring Group, “the once independent and more stable syndicated loan markets are instead beginning to move in lock step with more volatile bond markets. This leaves private “club lenders” as the primary committed source of lending capital in down or weak markets, as we are experiencing of late.”

Moreover, the Report points out that the loss of committed capital from CLO funds in the syndicated loan markets for middle market borrowers is “akin to the M&A Markets seeing a transition from financial buyers consisting mostly of private equity, to a world where private equity became a fraction of the market and most financial buyers were hedge funds, high net worth individuals and family offices. A market void of the stability offered by private equity would suffer from materially more volatility.”

Notable, too, says Morgan Joseph’s restructuring Report, is that recycled CLO capital, though still representing approximately 40% of the leveraged loan market, is quickly declining. It says that relatively few new CLOs are being printed (less than $12 billion so far in 2011), and nearly $50 billion in CLOs are reaching the end of their investment window.

“As these legacy CLOs roll out of the leveraged loan market, leveraged loans will be increasingly funded by relative value capital, ensuring a loan market of even greater correlation to that of the bond markets,” it comments. Thus, the importance of the private balance sheet lending market made up of banks, lending funds, mezzanine providers and hedge funds becomes that much more critical for smaller middle market and storied borrowers with a financing that may not appeal to the broad market.

The Morgan Joseph Restructuring Report also notes:

With fewer large bankruptcies, the average facility size for DIP financing continues to fall and increasing numbers of pre-petition lenders are finding themselves as the DIP lenders. Thus, in addition to providing new capital, lenders are looking to reprioritize their pre-petition debt and place themselves in the driver’s seat regarding any plan of reorganization or sale pursuant to section 363 of the Bankruptcy Code. In addition, it notes that DIP pricing has remained high, with both smaller credits under $100 million and larger credits between $101 and $500 million approximately 100 bps higher than at this time last year.
Hedge funds and high yield accounts have surpassed CLOs as the largest investors in new broadly syndicated loans.
The appearance of the beginning of a CLO comeback in the second quarter was merely a façade, with 76 percent of the legacy CLO vehicles – a total of $148.8 billion – due to reach the end of their reinvestment periods by the end of 2013.
The Asset Based Loan market is experiencing fierce competition as money center banks and loan funds look for “safer” investments in an effort to dilute their share of real estate and riskier commercial loans. Average pro rata spreads on ABL deals are below 200 basis points, down from 306 bps in the third quarter last year. Commensurately, commitment fees are down to approximately 42 bps on average.
Bank and non-bank balance sheet lenders are becoming more selective, but placement opportunities for subordinated tranches remain, as most "mezz" funds are dedicated to primary originations. Additionally, strong loan market activity in recent years has left mezzanine dollars on the sidelines, so that “mezz” dry powder of $10.1 billion is at the highest level since 2008.

About Morgan Joseph TriArtisan LLC

Morgan Joseph TriArtisan LLC (www.mjta.com) is an investment bank engaged in providing financial advice, capital raising and private equity investing. The firm’s services include mergers, acquisitions and restructuring advice, in addition to private placements and public offerings of equity and debt, as well as research for institutional clients.

Note to the Media: A copy of the full report is available by contacting Cristina Bacon, of Anreder & Company, at cristina.bacon@anreder.com, or 212-532-3232.