July 29, 2024 - During the second and final week of the LSTA’s 2024 Summer Series, the LSTA staff shared their own insights with our members on two key areas. On Monday, July 22nd, Elliot Ganz and Andrew Berlin presented a webinar, “Regulation and the Loan Market” during which they discussed the LSTA’s approach towards advocacy and policy. On Thursday, July 25th, Ted Basta, Ellen Hefferan, and Hugo Pereira discussed “Secondary Loan Trading and Trade Settlement”. Both of these webinars are recapped below.
There are three avenues of engagement available to the LSTA’s advocacy and policy team: legislative (Congress); regulatory (banking agencies and the SEC); and judicial (courts). On the legislative side, Congress passes laws, including financial services legislation and bankruptcy related laws. The House and Senate work on a committee structure, and those committees have jurisdiction over different areas of law. The LSTA focuses primarily on the House Financial Services Committee and the Senate Banking Committee which have jurisdiction over financial services legislation. House and Senate Judiciary Committees have jurisdiction over bankruptcy related legislation.
On the regulatory side, the SEC has jurisdiction over broker-dealers and importantly registered investment advisors (private funds and ‘40 Act funds). Virtually all the institutional lenders are registered investment advisors and are subject to SEC jurisdiction either as registered investment advisors or ‘40 Act mutual funds. The Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation are the prudential banking agencies that regulate banks. Other notable regulators include the Financial Stability Oversight Council which is led by the Treasury Department and provides comprehensive monitoring of the stability of the U.S. financial system. Thus, although the loan market, itself, is not regulated, loan market participants most likely are regulated.
On the judicial side, the courts play an important role, and in the past couple of years in particular, they have played a critical role in the loan market. Members learned how in litigation under the Administrative Procedure Act, federal courts are asked to determine whether federal regulators have the statutory authority to impose a rule. Courts are also asked to determine whether federal regulators acted in an “arbitrary and capricious” manner in proposing a rule. If the courts find that the regulators have indeed exceeded their statutory authority or if find they have acted in an arbitrary and capricious way, the courts may stay or vacate agency rules or require the agencies to amend a rule to comply with their ruling.
The policy tools available to the LSTA team were then highlighted, and they include education, research and data, engagement with different stakeholders, and litigation.
Two case studies were then analysed. First members learned about the private funds advisor rule (PFAR) which had been proposed by the SEC. As proposed, the PFAR would have restricted private funds from engaging in many common practices and impose high costs on them. The PFAR relied on dubious statutory authority from the Dodd-Frank Act. Initially covering CLOs as well, the LSTA was able to persuade the SEC to exclude them in the final rule. The LSTA and other trade associations commented on the PFAR proposal but also prepared to litigate believing that the SEC did not have the necessary statutory authority. Ultimately, the trade associations sued under the APA alleging that the SEC lacked statutory authority and acted in an arbitrary and capricious manner. Fortunately, the Fifth Circuit vacated the PFAR in its entirety, holding that the SEC lacked statutory authority to create it.
The second case study was on the significant growth of private corporate credit – leveraged lending to corporates by non-banks – which has attracted scrutiny from regulators and the press, and on what the LSTA is currently doing in that space. Regulators have published reports lately that focus on private credit, and there seems to be agreement that private credit does not create a systemic risk; however, regulators are concerned about the relative lack of transparency of private credit and the potential for this to obscure risk.
Although there are no imminent legislative or regulatory threats, the LSTA is working proactively to address any forthcoming scrutiny. The LSTA has, therefore, established a Private Credit Senior Advisory Committee (an agenda and strategy setting committee), a Markets Committee (the operating committee which will be tasked with execution of the projects) and an Established Operations Group (this will focus on deal structuring, loan servicing, and trading and settlement, among other things).
The LSTA has, therefore, been actively engaged in Washington, meeting with Congress, the regulators, the press, and academics, and is coordinating with other trade associations that have an interest in private corporate credit.
The presenters concluded by highlighting the LSTA’s affiliate, the Business Loans Coalition, and encouraged members to join on an indidvual basis.
The LSTA 2024 Summer Series concluded on July 25th with the webinar on “Secondary Loan Trading and Settlement”. Loan returns continue to be boosted by higher base rates. Higher rates were the reason loans performed well across corporate credit. The high demand for loans has tightened average bid ask spreads, but it has also propelled loans to the highest price levels in the secondary market for the past couple of years.
The high investor demand has been a big driver in the loan market. CLOs have had gross issuance of more than $100 billion thus far this year, and retail demand has also returned. This high demand in the market has also pushed up the number of loans trading above par, which in turn has impacted repricing and refinancing activity. The last time the median trade price was at or above par was three years ago. More than half the secondary market is now trading above par. When a loan trades at or near par, the borrower will typically be able to refinance their debt.
The first half of the year was busy, but deal making remained below long-term levels. Despite an uptick in new money lending, index outstandings are slightly down this year. This year we have also seen direct loans being refinanced by the BSL market, which will be something the LSTA will continue to monitor.
In 2024, secondary trading volume remained strong in the second quarter of the year, pushing the first half volume to the highest level since 2022. Two data points that help determine the loan market’s liquidity is market breadth and market depth. About 55% of loans have traded more than 20 times per month this year, and over the last twelve months, on a day-to-day basis, on average about 613 trade daily amounting to about $3 billion per day.
Average par settlement times trended lower in the second quarter of this year, with the median par settlement time flat at 12 days. One third of loans this year have settled within T+7. These par settlement times have improved over the past few months, and the times are, in fact, the best seen in the past few years.
The distressed market has been relatively quiet this year, and less than $3 billion has traded on distressed paper. Defaults in the loan market have ticked up but remain contained and decreased in June to 4%. The LSTA has only published six distressed shift dates in the second quarter. Although distressed settlement times moved higher in the second quarter they remain well below their three-year average.
Members then learned how to settle a loan trade. The LSTA has both a Par Confirm and Distressed Confirm. Each Confirm is divided into two parts: the first part includes the transaction specific terms (TSTs) and the second part includes the standard terms and conditions. The TSTs include all the specifics of the particular trade, including the names of the buyer, seller, and borrower, details of the credit agreement, and the purchase rate. Loan trades can settle by assignment or pariticipation. Notably, once parties agree the material terms of their trade, they have a binding contract – whether or not a confirm is ever signed. Following the mantra “a trade-is-a-trade”, even if the trade cannot settle by assignment, it must settle by participation. If the trade cannot settle as a participation, the parties must according to the LSTA Confirm “settle on the basis of a mutually agreeable alternative structure or other arrangement that affords Buyer and Seller the economic equivalent of the agreed-upon trade”.
Certain key trading conventions and terms were then highlighted. LSTA Confirms provide that, while a trade is open, a Seller need not solicit the Buyer’s vote with respect to any amendment or waiver; however, it was noted that the market practice is for sellers to consult with their buyers.
The different trading conventions were also explained. Settled without Accrued Interest (“SWOA”) is the preferred convention for trading performing loans in the market and shall apply to par trades unless the parties specify otherwise at the time of trade. SWOA generally provides that interest and fees that accrue prior to but excluding the settlement date belong to the Seller, irrespective of which party receives the payment, and after that date, they belong to the Buyer. Members also learned about delayed compensation which is generally owed to a performing buyer when the trade does not timely settle. Parties should also note that the credit agreement may also set out a minimum sale amount.
A Buyer settling via assignment must satisfy the definition of “Eligible Assignee” as defined in the applicable Credit Agreement. In addition, the buyer must not be on any disqualified lender list which the borrower has made. Our members then learned how interest should be paid on late settling trades with helpful examples provided.
We welcome feedback from our members on the Summer Series, and the topics they would like covered next year. We are considering adding a third week for the 2025 summer series and, therefore, welcome your ideas. Click here for the slides and replays.
