The Wall Street Journal
By: Carrick Mollenkamp
June 21, 2011
Banks and other lenders are engaged in an increasingly pitched fight for some corporate borrowers, raising concerns among analysts and regulators that the banks aren't charging enough to cover the risk they are taking on.
The battle to make loans, in contrast to the credit squeeze of recent years, is being driven by two factors: demand by investors for these loans and desire by banks to boost their revenues, which they have struggled to do recently.
"These guys are kind of climbing over each other" to increase loan volumes, said William Schwartz, senior vice president in the U.S. financial institutions group of ratings firm DBRS. His said his concern is that banks are relaxing their lending standards to make more loans.
Mr. Schwartz's firm and others have warned in recent weeks that banks are cutting loan prices and standards to win deals. The loan deals come amid a broader challenge for banks of making as much money as they potentially could on a slew of assets they hold.
In an analysis last week, Atlanta financial-institutions research firm FIG Partners said that the difference between what banks earn on assets and what the spend on funding costs--known as "spread"--fell for many banks for assets such as government bonds, mortgages and company loans in the first quarter compared with the fourth.
The average yield on leveraged loans has fallen to about 5.65% from 7.22% at the end of the year and 6.57% in the same period a year ago, according to Standard & Poor's Leveraged Commentary & Data Group.
Regulators are monitoring the situation, especially in the riskier leveraged-loan market, where banks and lenders such as mutual funds and loan pools provide floating-rate loans to non-investment grade companies.
"The dynamics of competition are very much on display, including...the pressures on arranging banks to maintain their market share," Federal Reserve Vice Chairwoman Janet Yellen said in a speech this month in Tokyo. "We will therefore continue to watch conditions in the leveraged-loan market closely in the coming months."
At issue is the loan market where in which banks arrange "floating-rate" loans for companies and then syndicate, or sell, pieces of the loan to investors such as mutual funds and loan pools. These loans are unique among fixed-income vehicles because they benefit from, rather than get hurt by, rising interest rates, making them attractive to investors.
Because of that feature, investors have poured money into these loans in recent months. So far this year, according to Morningstar, these funds--also known as bank loan portfolios--have taken in $21 billion in new money from investors. Their assets have grown by 50% in just five months and have more than doubled over the past year to some $70 billion.
In their push for new business, banks are reducing standards, including one that put a cushion under the interest rate charged on a loan. Those cushions were effectively a minimum amount a borrower would pay above a key bank-borrowing index--to ensure borrowers pay a higher amount than the benchmark rate.
But in recent months, banks and institutional investors have been reducing loan "cushions" in deals with borrowers amid rising demand by institutional investors for buying syndicated loans.
"That's possibly a strong indication that market terms are softening and borrowers are able to negotiate better terms for their loans," said Lee Vanderpool, a bank and finance lawyer at Pepper Hamilton LLP in Philadelphia.
These cushions--in loan parlance, Libor floors--are included in floating-rate loans to company borrowers. The floors are falling as lenders chase borrowers. Loan deals in recent weeks have included Libor floors of around 1.25%, down substantially from around 3.30% at the beginning of 2008, according to Standard & Poor's Leveraged Commentary & Data and Barclays Capital.
Borrowers have been the big winners in recent months. Last month, Manitowoc Co., a Wisconsin manufacturer of cranes and commercial food-service equipment, refinanced existing debt in a new $1.25 billion loan package. The company cut its interest rate to three percentage points over Libor, extended the date the debt matures by several years and lowered the Libor floor on a portion of the loan facility by 1.75 percentage points to 1.25%.
Finance chief Carl Laurino said Manitowoc was prepared to accept a higher Libor floor "if the market was tougher than it turned out to be."
Mr. Laurino says Manitowoc will save $13 million in its first year of borrowing costs under the new loan deal.
Morgan Keegan & Co. analyst Robert Patten said the need for growth is driving banks to deploy their excess capital into higher risk loans.
"It's the curse of cash," Mr. Patten said.
Write to Carrick Mollenkamp at firstname.lastname@example.org