Credit provision is once again becoming a dangerous game. Tight bond spreads on high-grade, high-yield or emerging-markets paper are one obvious warning sign that investors? desperate chase for yield has overcome any sensible discrimination about underlying credit risk. But the clearest indication that institutions have failed to learn from the last recession and credit crunch is in the syndicated loan market.
Just two years ago many of the so-called retail, or, to use a more pejorative term, stuffee banks were pulling out of the syndicated loan market or significantly scaling back their commitments.
Loan and credit losses had scared them. Even though this was precisely when the banks should have been able to extract a much better return on their risk, structural absurdities prevented them from achieving this. The face-value terms of many deals were still ludicrously generous, reflecting more the desire of commercial banks to pick up other business than the true underlying risk of borrowers.
A few smarter banks found ways of picking up a better return. The commercial and investment banks in the upper echelons of the syndicate were offloading exposures at low prices either in the grey market ? the unofficial secondary market for loans not yet closed ? or through credit derivatives.
Now, though, and over the past six months or more, stuffee banks from Europe and the US have been jumping back in with abandon. Even Japanese banks are moving back into US syndicated loans, having retreated in the second half of the 1990s.
After several years of cutting back their exposures, all these banks now need to be seen to be lending. Without such activity it?s more difficult to persuade investors in their equity that core earnings are on an improving trading and that the prop trading play is not as central to their earnings.
Many of these banks now employ various equity-based risk-management models to judge risk exposures. Nevertheless the mere fact that many borrowing companies? market capitalization has increased might skew perceptions of absolute risk.
The trouble is, corporates have nowhere near as much desire to raise capital as the banks have to provide it. The banks are falling over themselves to lend, and are disappointed when an allocation of, say, $225 million is cut to $75 million because competition to provide is so tough.
That has an impact on pricing. It?s a long time since loan pricing reflected the economic realities of providing the loan on a standalone basis. Pricing only improved slightly, from the banks? perspective, during the bad years. Even that modest improvement has now been reversed.
Corporates might not be desperate to borrow huge sums for capital investment and takeovers. But they aren?t shy and retiring, either. They?ve worked out how to take advantage of these banks? desperation to lend, and that is to lock in more long-term money than before. One-year facilities used to dominate the loan market, making up 66.5% of the total at the end of March 2003, according to Bank of America Securities. A year later that figure had virtually reversed, with multi-year loan facilities ? essentially three-year and five-year deals ? accounting for just under 60% of the market: it had been as high as 66.7% earlier in 2004.
Commercial banks probably feel more comfortable with five-year facilities than their investment-banking brethren. The disappointment for them is that a bigger balance sheet has proven not to be the be-all and end-all to winning high-margin investment-banking businesses. Both the debt and equity capital markets league tables in the US show some, if not all of the pure investment banks holding their own. They have simply had to adopt a more structured and focused approach to using balance sheets.
Pushing more five-year facilities might put a bit of pressure on the investment banks, but it?s not good risk management: it?s much harder to act on which sectors and credits are hot or not if you?re agreeing to more and more long-term loans.
Investors themselves should not forget that banks have very short memories.
