Banks no longer need to lure institutional investors into the syndicated lending market with high yields and favorable terms.
Institutional investment in bank loans has risen to an estimated $30 billion, according to investment bankers, and the interest among pension funds and mutual funds shows little signs of slowing.
Further, banks arranging large syndicated deals have been able to cut the pricing and increase the duration of the investors' portions of transactions.
Three years ago, institutional pieces of loans on average were priced at the London interbank offered rate plus 300 to 325 basis points and were seven years in duration, bankers said.
Today, those terms are quite different. In one sign of investor demand for the loans, Chase Manhattan Corp. recently brought a $650 million loan to market for Morris Communications that contained an eight-and-a-half-year institutional portion priced at the Libor plus 150 basis points.
Chase said the lower price reflected the credit quality of Morris and the supply-and-demand dynamics in the market.
"There are a lot more players investing in loans as an asset class," said a Chase official. "Some of those players are prepared to take lower returns, particularly in this environment."
Bankers said that the influx of capital into the market underscores the increasing accessibility and maturity of the bank loan product.
"We see the convergence of the public and the private debt markets in the institutional loans," said Robert C. Griffin, executive vice president at BankAmerica Corp.
"A lot of nonbank investors in the past shied away from the sector," said Jim Karp, a syndicate manager at Goldman, Sachs & Co. "They had no confidence they could actively manage a portfolio."
Investors now have familiar analytical tools such as ratings from Moody's Investors Service and Standard & Poor's Ratings Group to assess loans. Additionally, the formation of the loan syndication and trading association has enhanced liquidity and fostered standardization.
"These things legitimize the market and make it more understandable to those not accustomed to dealing with it," said Mr. Karp. "All that fosters liquidity and drives convergence."
Banks are among the newer investors in institutional portions of loans. Initially banks had avoided this asset class, but have warmed to the higher yield.
"The relative value assessment of the banks has changed over time," said Bruce Ling, the head of syndications at Credit Suisse First Boston.
"Banks initially saw better relative value in shorter maturities, but over time they've grown comfortable in the valuation that says that the risks are very similar and the returns are that much better."
But bankers said that lower pricing on the institutional portions of loans reflects a similar compression on the portions structured for banks.
"The funds are faced with the realities that all of us are faced with: There is too little supply and too much demand," said Mr. Ling.
Bankers said the convergence between the public high-yield and bank loan market may push pricing on institutional loans down even further as borrowers attempt to take advantage of relative price differences.
Chase recently increased a high-yield deal for Kohlberg Kravis & Roberts to $300 million from $200 million in the face of strong investor interest, while decreasing the institutional loan by $100 million.
"The increased level of liquidity in the high-yield sector could lead to further pricing pressure on institutional tranches," said a Chase official. "Banks active in both markets can take advantage of that convergence."