At the start of the year Lucine Kirchhoff took a bold position. The price of high-grade loans, she said, was destined to increase: “Look for investors to focus more on drawn pricing to compensate for the appropriate risk they are taking,” said Kirchhoff, the head of loan syndicate at Banc of America Securities. It would be a similar story for undrawn costs. Higher pricing ought to have been inevitable given the recession, a rise in defaults, rating-agency downgrades and fallen angels, and the uncovering of corporate frauds. Banks would surely be looking for a much better return for the risks they were taking, which would imply a wholesale change in prices rather than just a slight increase.
On a percentage basis this has happened. In July AOL was forced to pay an interest rate for its undrawn 364 revolver that was 31% higher than the rate it agreed to the previous year. It might seem a large increase in percentage terms but it amounted to just 2.5 basis points, taking the rate from 8bp to 10.5bp over Libor.
This wasn’t what Kirchhoff had in mind. “While most pricing levels are higher than last year, pricing has drifted up slowly rather than spiking as some of us had expected,” she says now. And it’s not been an increase across the board. Compared with last year costs for some ratings bands have actually decreased: A+ for undrawn costs, A and A- for drawn spreads and straight triple-B for both.
How much loan pricing ought to have increased, however, is a matter for contention. Unsurprisingly, the pure investment banks would like to see a huge increase. “Pricing hasn’t changed, really,” says one head of lending at an investment bank. “There have been some modest increases, but from 25bp to 50bp. To reflect the risk involved it ought to be going up to 500bp, or more for some corporates.” It’s a point reinforced by Robert Wagner, head of syndicated lending at Goldman Sachs. “We haven’t seen any rationality in pricing. It’s moved by basis points, but needs to move by points.”
Kirchhoff thinks this is going too far. “The market is underpriced, but not by as much as the investment banks would like to say. At the beginning of the year I had expected pricing to increase more than it has. I thought we would see drawn costs increase by about 50%, and undrawn costs rise to be closer to 50% to 75% of the drawn cost.”
Even without increasing drawn costs, this would have pushed AT&T’s undrawn costs for the $4 billion revolver to between L+57.5bp bp and L+86.25bp, much more than the L+15 bp they are paying.
Why it hasn’t happened is simple. “In part it is because banks still do view loans as part of an overall relationship,” says Kirchhoff. “But also the banks have been so distracted by other matters that changing loan fees hasn’t been a priority.”
There have been other changes this year. One is simply that companies aren’t borrowing as much as they used to. AT&T’s previous revolver, last December, was for $8 billion, a year before that it was $12 billion, and had been as high as $20 billion in the late 1990s. It’s the same with many other companies. Some of this is the result of a decreased need for such large facilities; AT&T, for example, is not as large a company as it used to be. Others have been forced to term out debt because their access to the commercial paper market has been stymied or closed. And that obviates the need for a revolver as a backstop.
Look to institutional investors
Banks are becoming more cautious. Fewer banks are taking part in lending because they don’t believe they’ll make enough from other business from the borrower, be it in foreign exchange, bonds, or something else. And banks are adapting to increased risk. “The market realized that it was way too overexposed at the short end,” says Bruce Ling, co-head of lending at CSFB. So there’s been a shift to longer-term loans, which, though still underpriced, pay better. Meanwhile, institutional investors are becoming more significant lenders to certain groups of companies, notably triple B rated names. Thus far this year, according to Bank of America Securities, 11 deals have been sold to institutional investors in the US, raising just under $3.4 billion compared with $2.17 billion from 10 companies last year. The cheapest spread is 200bp over Libor, the most expensive 450bp over. The average is 284bp over, which is two-and-a-half-times more expensive than the Libor plus 115bp drawn price for AT&T’s $4 billion revolver, and four-and-a-half times more expensive than AOL’s 62.5bp over. And the triple B sector is supposed to be where prices have moved most in syndicated loans. If institutional pricing represents fair value for loans as a stand-alone product, the syndicated bank lenders still have a long way to go.
