A couple of years ago, banks started bending over backward to attract institutional money to the syndicated loan market. They rewarded mutual funds and prime rate funds handsomely for taking pieces of loans that were as many as three years longer than the typical bank credit.
Now banks want a piece of the longer-term action. They have watched most institutional tranches of loans get refinanced well before their maturities and are now more comfortable holding these pieces.
As a result, banks are snapping up tranches of loans designed specifically for the institutional market. By so doing, they are running the risk of alienating some of the very same investors they so actively courted just a few years ago-an action that could come back to haunt them.
"If they want to stretch the market, and stretch their good will, so be it," said Jeffrey Maillet, the portfolio manager who oversees the $6 billion Van Kampen Merritt fund, the largest institutional investor in the syndicated lending market. "It's their deal. Who are we to criticize it?
"Right now, we've got a bull market, and that's going to change. When it does, we're just not going to hear them when they want something," he added.
Institutional investors like Van Kampen Merritt are active participants in the secondary market, which lenders use to manage their exposure to particular sectors.
In some cases, it is borrowers who mandate that banks get to buy the institutional pieces of their loans, which typically carry fees 100 to 200 basis points richer than on the average bank loan. Some customers, like buyout firms, use this strategy to reward banks that invest in the funds they run.
Kohlberg Kravis Roberts & Co. for example, recently required that banks get first dibs on the $400 million institutional portion of a $750 million loan it issued for the leveraged buyout of Amphenol. It was the third time in recent months that KKR had favored banks. The other two were loans supporting its purchases of Kindercare and Spalding and Evenflo.
"Companies like KKR do this because they're trying to do someone a favor," said a lender at a large New York bank. "That's the main reason. It's really more of a bone they are throwing at someone."
Media is another sector in which banks have begun investing in institutional loan tranches. Bank lenders to that industry are increasingly requesting access to the institutional portions of loans because they are used to longer-lived deals, said a syndicated lender at a large New York bank.
Eight- and nine-year terms "are familiar territory," he said.
Still, mutual funds and prime rate funds continue to control the lion's share of the institutional loan marketplace. Many banks remain uncomfortable holding pieces of loans with longer maturities. Even banks that invest in these tranches often sell their holdings quickly, earning the nickname "flippers."
"Banks don't have the (guts) to hold on to the paper the way we do anyway," said Mr. Maillet. "They'll flip it to brokers because they can't syndicate it themselves, and I'll eventually end up with $60 million of it."
Market participants also pointed out that banks are buying institutional pieces at a time when the rewards for doing so are shrinking.
"With new-issue supply down and faster refinancing of recent deals, the institutional pieces are experiencing pressure on spreads," said Bram Smith, head of syndications at Morgan Stanley & Co.
Indeed, Mr. Maillet said, he has turned down more deals in recent months because of poor pricing and structuring.
However, institutional tranches remain attractive relative to other types of loans.
"Pricing on traditional bank portions has compressed more than pricing on the institutional tranches for new issues," said Bruce Ling, head of syndications at Credit Suisse First Boston.
Banks are not the only new entrants vying for a piece of the institutional loan market. There now are 38 institutions in the lending business, up from 17 four years ago, according to Loan Pricing Corp./ Gold Sheets. And bankers said they are loathe to alienate them.
"It's a tough line to walk," said a syndicated lender at a large foreign bank. "The nonbanks are huge players in providing liquidity in the secondary marketplace, but it's frustrating as a bank not to be allowed to get that higher-yielding paper."