As more institutional investors have piled into the bank loan market this year, returns on tranches designed for these buyers have fallen markedly.
The investors, including insurance companies and prime-rate funds, have been clamoring for tranches of leveraged loans with longer terms. As a result, the fees and spreads on those tranches fell throughout the first half, continuing a drop that began in 1995.
For example, the average spread over the London interbank offered rate for those tranches in refinancings fell to 219 basis points, from 262 last year, according to a new report from Portfolio Management Data LLC.
Investors, however, said they will keep snapping up the instruments as long as the returns continue to meet or exceed those of high-yield bonds.
"If you look at the asset class on a stand-alone basis, it's still pretty compelling. Does it get pushed to the point where it's no longer attractive? You'd have to push a little more," said Mark L. Gold, managing director at Trust Company of the West, who manages more than $1 billion in a high-yield bank loan portfolio.
The decline in yield follows a pronounced fall in prices for investment- grade loans. That squeeze began in 1994, when returns on high-yield loans were holding steady.
"Institutional lenders were able to resist pricing declines earlier in the cycle because there were so few players in the market. That, of course, is no longer the case," said Steven Miller, principal of Portfolio Management Data, a leveraged-loan data base and analysis service in New York.
Indeed, the number of institutional bank loan investors has almost quadrupled since 1993, to 55 investors at midyear, Mr. Miller said. These investors almost exclusively buy leveraged loans, especially tranches with longer terms or no amortization.
At the same time, a number of banks have been moving into leveraged loans from lower-yielding credits.
"There are just no profits in the investment-grade loan sector," said Mr. Gold.
"That's creating greater appetite on the part of the foreign banks and the regional banks in the market."
That growing appetite for institutional term loan tranches, known as B- term, C-term, and D-term loans, has given syndicating banks the option to reduce pricing and still find deals greatly oversubscribed, said Mr. Miller.
One loan currently in the market may set a new benchmark low for fees.
Bankers Trust New York Corp. is syndicating its $1.245 billion credit for Goodman Manufacturing but is not initially offering any up-front fee on $450 million in term B and term C tranches, according to a lender familiar with the deal.
That deal, backing Goodman's acquisition of Raytheon Co.'s home appliance division, is set to close Sept. 10, according to Loan Pricing Corp.
