Coming off a quarter of record-breaking volume, participants in the loan syndications market are increasingly turning their attention to what will happen when the current business cycle bottoms out.
Pointing to the scores of investment banks, institutional investors, and other players that have entered the syndications business during an unprecedented boom, some established participants say a shakeout is on the horizon.
The new entrants have never weathered a loan market downturn like that of the early 1990s, said experienced syndicators. And the transaction and trading mind-set of some of the business' newest competitors is not well- suited to a bearish market.
"The art of lending money is not tested in a time like the one we're in right now," said James B. Lee Jr., vice chairman of Chase Manhattan Corp. in charge of global investment banking.
"The test is when the wheel turns: How many decisions that you made were good ones, how many weren't, and most importantly, are you prepared to act as partner with your customers and work through the issues?" he said. "That's when bankers are made."
Mr. Lee's remarks came during the keynote address to a gathering of 83 syndicators, institutional investors, loan traders, credit risk managers, and bank examiners in New York this week for a risk management conference. The event, sponsored by Robert Morris Associates, brought out the bearish side of lenders otherwise occupied with a surging loan market.
High on the list of concerns aired was the fate of the growing crop of relative newcomers to the syndicated lending market. These include investment banks with active syndication efforts, such as Goldman, Sachs & Co., Merrill Lynch & Co., Lehman Brothers Inc., Morgan Stanley & Co., and Salomon Brothers Inc., as well as institutional investors and secondary market loan traders.
"We worry about the transaction mentality" of some of the market's newest players, said George E. Matelich, a managing director at Kelso & Co., a New York sponsored-deal firm.
Adding to the worries is an increasing sense that credit quality is beginning to deteriorate.
"We're looking at the market with a much more skeptical eye than a year ago," said John Wheeler, an investment director at MassMutual Life Insurance Co., which holds about $1 billion of floating-rate bank funds.
Howard Tiffen, a senior vice president and portfolio manager at Pilgrim America Group, which has more than $1.2 billion invested in senior loans, said that credit quality is not as shaky as it was in the late 1980s. But he cited the disappearance of a few key covenants, such as debt to EBITDA (earnings before interest, tax, depreciation, and amortization), as signs of looser credit risk management in syndications.
Meanwhile, syndication periods will "continue to compress," predicted Kevin Burke, a managing director at Bankers Trust New York Corp. and its head of syndications. That will put even more pressure on the market to make faster credit decisions.
Adding to that pressure is the growing competition for the longest term and highest yielding tranches of the high yield loans-those pieces that were formerly set aside for institutional investors.
The rationale for excluding banks from those tranches "has been artificial, and is effectively beginning to disappear," said Mr. Burke. This kind of investor crossover is "here to stay," he said, accompanied by spread and fee compression.
What a bear loan market would do to the rapidly expanding secondary loan trading business is also a mystery.
"This market barely existed through the last bear market," said Jonathan Calder, a managing director at Citicorp Securities and one of the few loan traders who experienced that downturn. Par and distressed loan trading, only recently coming into its own, is essentially a "long" business, and all trading desks will lose money at the onset of the bear market, said Mr. Calder.
He tried to develop a technique to "short" on the secondary loan market in the early 1990s but found little success, he said.
Senior credit policy staffers and credit risk portfolio managers at the conference found additional disturbing trends in the syndication market.
"In my view, CFOs are laughing at what they can get from banks now," said David L. Eyles, executive vice president and chief credit policy officer for Fleet Financial Group.
Teaser rates on corporate loans, few or no covenants, interest only arrangements, and ever-lengthening terms are growing more common, said Mr. Eyles, and will come back to haunt lenders in the long run.