Despite a sluggish first quarter, the leveraged loan market is expected to grow this year, fueled by fantastic levels of liquidity and rising investor demand.
At least, a new study by BancAmerica Securities' loan syndications research unit predicts it will. Steven D. Oldham, the study's author, pointed to several factors, including the billions of dollars raised by equity sponsors last year and a glut of deals in the high-yield market, as evidence that a leveraged lending boom is about to begin.
"The high-yield market has backed up, giving the relative value edge to the loan market," Mr. Oldham said.
During the first quarter, leveraged lending volume fell 22% from the fourth quarter of 1996. A booming high-yield bond market was partly to blame, as it diverted activity away from leveraged loans.
But Mr. Oldham and others said the tide is about to turn.
One key factor is the huge appetite that institutional investors have developed for bank loans. The low levels of risk per unit of return have made leveraged loans an important asset class for insurance companies, hedge funds, collateralized loan obligations, and prime rate funds such as Pilgrim America Prime Rate Trust, Eaton Vance Prime Rate Reserves, and Merrill Lynch Senior Floating Rate Fund.
Prime funds "are taking progressively bigger pieces of the loans offered," said Michael Zupon, a managing director in leveraged finance at Merrill Lynch & Co., "but the individual funds and lenders are getting progressively smaller allocations in the deals."
The number of these institutional investors has more than doubled since 1994; 46 institutions now compete among themselves and increasingly with banks for tranches of the credits, according to the study by the BankAmerica unit.
These investors now buy 31% of highly leveraged loans, or those with spreads of 250 basis points or more over the London interbank offered rate, excluding the underwriting banks' holdings.
One of the largest boosts to the leveraged lending market is expected to come from the equity sponsors or buyout firms. These sponsors, including firms like Kohlberg Kravis Roberts, DLJ Merchant Banking Partners, and Hicks, Muse, Tate & Furst, raised $22.6 billion in 1996, more than 80% of which remains uninvested.
That money is a store of "dry powder" that is waiting to be put to work, Mr. Oldham said.
Deal firms currently account for only 30% of leveraged loans, but the majority of those deals flow from the top few funds, making them crucial to banks' high-yield origination efforts, said Mr. Oldham.
High equity values have kept many public firms too costly for buyout firms to make deals, and that pressure has carried over into private deals, too. Competition from strategic and financial buyers, those corporations that can use stock as currency and extract greater value from acquisitions via competitive synergies, has also kept the deal firms at bay.
Since investors in these funds expect high returns, the sponsored buyers must bide their time until market conditions are more favorable to begin using their reserves. The time will come, lenders said, when the market becomes convinced equity values have peaked.
"A number of big pieces of the puzzle are in place," said Mr. Oldham; namely, the accumulated funds and the environment for raising debt capital. "Those point to continued high, and incrementally higher, volume," he said.
Deal firms have also diversified the industries they operate in. Traditional sectors such as food and beverage and construction and building materials now account for less than half the volume of sponsored, leveraged loans as in the late 1980s. Manufacturing now tops the list of deal- producing sectors, with 18% of the volume last year, along with the forest products, services, and health-care industries.