The number of smaller commercial banks buying leveraged loans rose sharply in the first half of the year and probably will keep rising, and the trend will affect how new deals are structured, market watchers say.
Underwriters will arrange larger term loan A pieces and smaller institutional tranches, these observers predict.
Participants said the return of commercial banks to the market could also have an impact on what types of deals underwriters shop because commercial banks, given their more conservative manner, are looking for better-quality paper.
"We're back to 1998. That was the last time banks had a decent share of leveraged loans, before CLOs dominated the market," said Randy Schwimmer, the head of capital markets at Churchill Financial.
"Today, banks are pumped up with liquidity, and CLOs are strapped for cash. That's compelling arrangers to restructure LBOs on bank-favorable terms."
This change in the leveraged loan investor base is difficult to quantify, given the private nature of bank agreements. However, evidence of this shift can be seen in several recent deals that were specifically arranged, or rejiggered, with commercial banks in mind.
In June, a bank consortium — JPMorgan Chase, Barclays and UBS — arranged a $570 million term loan backing Allscripts' acquisition of Eclipsys.
In July the banks changed the structure of the debt financing; all $570 million of it became a term loan A tailored for commercial banks.
The same strategy was used in the Gentiva-Odyssey HealthCare deal.
The lenders — Bank of America Merrill Lynch, Barclays, GE Capital and SunTrust — reworked Gentiva's debt package, reducing the size of an $800 million term loan B by $300 million and shifting the balance to a term loan A tranche.
Other deals that illustrate this trend include loans for AutoTrader.com and Canwest, sources said.
"A number of commercial banks have been busy raising capital and have seen assets run off," said a New York loan market analyst who declined to be named. "As a result, they are eager to put funds to work. I have heard this of the regional banks, but not smaller than that."
Sources declined to actually name the commercial banks that have gotten active in the leveraged loan market.
Some are newcomers, but others are returning from the sidelines to invest in attractively structured deals.
Several banks from Asia and the Middle East are buying leveraged loans, the sources said.
Opinions vary on how long these banks will remain active in the leveraged loan market — some said they're here to stay and others see them more as short-term players.
A leveraged loan makes for an easy sale to a commercial bank.
"It makes sense because traditional products like real estate are so heavily scrutinized and leveraged loans provide good returns without requiring much overhead for a small holder," said a California-based investor.
Not everyone believes that this change in the investor base is a good thing for the market.
Some think that commercial banks will add depth to the buy side, resulting in more deals because more buyers equals more deals.
Others say the result will be higher-rated, lower-yielding deals.
Some institutional investors fear their turf is being overrun.
"There's no question about it," a bank loan trader said.
Commercial banks "are definitely coming into our sandbox. And I'm generally not thrilled about it.
"If you look at some deals and how they are structured, you may see larger pro rata pieces in lieu of institutional tranches."
And then there is this: If banks are investing in leveraged loans, how much money are they investing in other areas, for example, small-business and commercial loans?
"How much of this trend is small banks retreating from giving credit to small borrowers even at a presumably much wider spread?" a second New York-based portfolio manager asked.