Qualitative Easing

“The food in this place is really terrible,” one elderly woman complains to her friend at a Catskill mountain resort. “Yeah, I know,” replies the other one, “and such small portions.”

That’s where investors find themselves today in the broadly syndicated market. With leverage up and spreads falling, deal quality is eroding. Yet thanks to wild oversubscriptions, most funds are getting measly allocations. Buyers who commit $20 million are allocated as little as $500,000. Contrast that with the lower middle market where companies are lucky to get any financing at all.

What’s going on here?

In a normal market, let’s say you launch a $250 million term loan. If the syndication goes well, you might raise $500 million from 35 accounts, with commitments ranging from $50 million down to $10 million. You can’t give everyone what they want, so you: 1) increase the term loan, 2) flex down the spread, and/or 3) reduce buyers’ allocations.

In this market, instead of raising $500 million, arrangers are getting swamped with over $2 billion in tickets. Blame that partly on the yield-starved environment we’re in, and partly on all that idle cash desperate for a home. But there are other factors at work.

Large revolving credits are critical to some issuers’ financing needs. One recent issuer, an HVAC manufacturer, had a $250 million RC as part of a $2 billion recap. Because they’re unfunded, RC’s are as popular with banks as an FDIC audit. So banks who take RC will demand more than their pro rata share of (in this case) the $1.5 billion term loan.

Also, the consolidation of portfolio managers has created a dozen or so asset monsters. These firms – Fidelity, BlackRock, Carlyle, Highland, and Apollo, to name a few – have enormous loan appetites. When they commit, each can speak for $100 million, or more.

And because of their size, these big dogs can say to arrangers, “If you want me to be an anchor ticket on your next mega-deal, you better treat me right on this deal.”

But it goes even further. Many of the largest fund managers do significant other business with the top syndication banks. Whether it’s bonds, M&A, trading, or equities, the amount of fee income involved is staggering. When it comes time to allocate the loan book, syndicators are hard-pressed not to bear those relationships in mind.

The discrepancy between haves and have-nots is growing. Over the last two years, according to S&P/LCD, 34% of allocations were $2 million or less. And this year, the top ten largest allocations as a group was double the next largest group. At the height of the loan boom in 2007, the top tier only had a 30% higher share.

We asked one syndicate veteran, why not flex Libor spreads down further to weed out buyers just looking to flip into the secondary? “It is a frothy market,” he said, “but if you push spreads too low, you’ll watch your book melt like a snow cone in Phoenix.”

If you think this institutional piling-on is bad now, what’ll happen next year to deal quality when new CLOs start coming on line? Call it QE3.

Durant D. “Randy” Schwimmer is Senior Managing Director and Head of Capital Markets for Churchill Financial Group. Schwimmer joined Churchill Financial from BNP Paribas Securities where he was a Managing Director and Head of Leveraged Finance Syndication. Prior to joining BNP Paribas, Mr. Schwimmer spent 15 years at JP Morgan Chase in Corporate Banking and Loan Syndications in various capacities. He may be reached at rschwimmer@churchillnet.com