For the first time institutional investors surpassed banks during the first quarter in the amount of capital they committed to leveraged buyout lending, the latest sign that banks are tightening their purses and reserving their assets for the most profitable relationships.
Portfolio Management Data, a research firm in New York, said that institutional investors provided 53.5% of the capital used by the leveraged buyout market in the quarter, compared with 46.5% from pro rata lenders, or banks.
Institutional investors market share has been rising since they first established a significant presence in the market in the mid-1990s.
Steve Miller, a managing director at Portfolio Management, a unit of the Standard & Poors credit rating agency, said that institutional investors held a market share of less than 10% 10 years ago but about 25% five years ago.
The institutional investor base continues to grow, Mr. Miller said. Eighty such investors made at least one deal in the first quarter, up from 74 in the previous quarter, he said.
Bankers say the pool of pro rata investors has shrunk as banks have merged and foreign banks have left the U.S. lending market.
In addition, bankers say they are moving away from the practice of holding large loans on their books, especially when they are not chosen to be the lead underwriter or think they will not generate additional fee income. This is paving the way for a bigger institutional presence in this market, they said.
Pro rata investors usually invest in the shorter-term segments of a loan, the revolver and A portions; institutional investors generally take the longer-term B and C segments. Observers say that, to attract more institutional investors, deals are being structured to put more attractive rates of return on the B and C segments.
The trend toward institutional investors taking a larger share of the market is going to continue as long as the return on the institutional portion is higher than the return on the pro rata portion, said Bob Woods, head of syndicated lending at Societe Generale. Weve been pricing to accomplish this.
Bankers say that banks typically get the London interbank offered rate plus 250 or 270 basis points but that institutional investors generally get 50 basis points more than that. Banks have relationship loyalty and other income that they use to rationalize the lower price of the pro rata portions, but even that is getting tougher, Mr. Woods said.
The pricing for revolving credits, which is now generally lower than the institutional segments, will eventually be adjusted because investors available to supply the revolving portions are growing scarcer, Mr. Woods said. This adjustment is already happening in the secondary market, where revolvers are getting prices equal to or higher than the institutional portions, he said.
Bankers say the demand for the pro rata capital has not diminished because borrowers still need a revolving piece of credit to cover working capital needs. But institutional investors do not have the back-office capacity to lend on a revolving basis, and they prefer to invest in loans with terms of five to seven years, bankers say.
Because of the smaller pool of pro rata lending and the steady demand for loans, bankers say they are increasingly able to charge larger fees and demand longer-term portions of loans.