A Look at 2020’s Remarkably Resilient Leveraged Loan Market

What happened with the leveraged lending market last year?

Not surprisingly, leveraged loan markets tracked very closely to the broader economy and enjoyed their own K-shaped recovery in the latter half of 2020. Face-to-face businesses and the energy industry faced headwinds brought about by the pandemic, while IT, health care and pockets within manufacturing managed to thrive and even grow.

Loan volume finished the year on a strong note after cratering to a four-year low during the second quarter, due to the initial shock of the spreading pandemic. Institutional loan issuance gathered steam through the summer; by the third and fourth quarters, issuance totals were in the range of 2019’s quarterly average of $77.5 billion, according to S&P Global Market Intelligence’s Leverage Commentary and Data. Much of the demand was driven by the re-emergence and recovery of the collateralized loan obligation, or CLO, market, buoyed by investors searching for yield in the low interest rate environment.

Loans supporting buyouts and acquisitions drove the fourth-quarter tally, surging 49% from the third quarter. New buyout deals had nearly dried up amid the economic uncertainty that gripped markets in the second quarter and into the third quarter, but private equity firms clearly have regained their confidence since then. There were 33 separate leveraged buyouts priced in the loan market during the fourth quarter, a pace not seen since the third quarter of 2018. Even as merger and acquisition issuances gained pace, sponsored issuers continued to take advantage of demand with opportunistic deals.

Secondary prices fell dramatically during the initial phases of the pandemic but have also recovered to pre-pandemic levels. The average bid of the S&P/LSTA Leveraged Loan Index reached 97.17 as of Jan. 12 — its highest level since the index was at 97.29 nearly a year ago, on Jan. 26, 2020.

While default rates have increased compared to recent record lows, they ended 2020 at a modest 4.22% as measured by number of issuers. This compares over 10% during the depths of the Great Recession. Leading the charge was face-to face industries, such as retail and leisure, in addition to borrowers in the oil and gas industry.

Looking forward to 2021, analysts at Bank of America Corp., Barclays and Wells Fargo & Co. have a relatively sanguine view and are anticipating a healthy market, with a rise in overall leveraged loan issuance. Analysts at JPMorgan Chase & Co. were slightly less optimistic with a prediction of a 10% decline in gross issuance, according to S&P Global.

Based on a survey of portfolio managers, technology and health care continue to lead the sectors that are expected to outperform in 2021. Given the magnitude of the shock to the system during the first half of the year, the default cycle is expected to be relatively short.

BancAlliance believes that the loan market should be able to sustain the robustness seen in the second half of 2020 performance through 2021, as businesses have successfully adapted to the new normal, in addition to the anticipation of the vaccine rollout. To start the year, we have already seeing a flurry of activity from the lower middle market, middle market and broadly syndicated loan space across a multitude of industries and transaction types, such as buyouts, dividends and repricings. We expect this energetic output to continue.

The Top SBA Lenders Fuel Small Business

SBA-loans-4-8-16.pngCalvin Coolidge once observed that “the business of America is business,” and if the 30th president of the United States were alive today, he would probably amend his statement to says “the business of America is small business.”

Indeed, small businesses—or companies with fewer than 500 employees—are the engine of the U.S. economy, accounting for 99.7 percent of all U.S. employee firms, 64 percent of net new private sector jobs and 49 percent of private company employment, according the the Small Business Administration’s Office of Advocacy. However, banking a small business can be an entirely different matter because as borrowers, they tend to fall into a high risk category. Only about half of all new businesses are still around after five years, according to the SBA, and only about a third survive 10 years or more. Most banks tend to be put off by markets where the likelihood of success or failure could be predicted by the flip of the coin.

Enter the SBA’s various loan guarantee programs, particularly its highly popular 7(a) program (named after a section of the Small Business Act passed by Congress in July 1953), which has been very successful in bringing much needed bank financing to the small business sector. In its 2015 fiscal year, which ran through September 30, the SBA approved 63,000 7(a) loans for a record $23.6 billion. In FY2014, the SBA approved 52,044 7(a) loans totaling $19.19 billion. While the 7(a) program’s annual loan totals are still well off their peak in 2007, when they approached 100,000, volume has been increasing since 2009, when demand dropped off sharply as the financial crisis and Great Recession caused many banks to pull back from most lending markets.

There are several SBA loan guarantee programs, including disaster recovery loans, microloans and financing loans for fixed assets like real estate and equipment. But the 7(a) program is the big daddy of them all, and can be used for a variety of purposes, including acquisitions, business expansion, working capital and debt refinancing. A regular 7(a) loan can be for as much as $5 million. Loans up to $150,000 can be guaranteed by the government up to 85 percent. For loans over $150,000, the guarantee limit is 75 percent. These are term loans with one monthly payment of principal and interest, with a maximum maturity of 10 years except for real estate. Real estate can be financed for a maximum term of 25 years.

The leading SBA 7(a) lender in FY2015 based on loan volume was San Francisco-based Wells Fargo & Co., which originated $1.9 billion in loans, followed by Live Oak Banking Co., U.S. Bancorp, JPMorgan Chase & Co. and Huntington Bancshares. Wells Fargo also originated the greatest number of loans in FY2015, at 7,254, followed somewhat surprisingly by Huntington, at 4,337. Wells Fargo—which is the third largest bank in the country with $1.78 trillion in assets—sources much of its 7(a) loan production through a coast-to-coast retail branch network, while $71 billion asset Huntington relies on a much smaller network of 750 branches in six upper Midwestern states, with additional loan production offices in Chicago, Wisconsin and Florida.

Top SBA Lenders in FY 2015
Lender State Approved Loans Approved Amount*
Wells Fargo & Co. CA 7,254 $1,918
Live Oak Banking Co. NC 966 $1,148
U.S. Bancorp MN 3,977 $776
JPMorgan Chase & Co. NY 4,040 $754
Huntington Bancshares OH 4,337 $673
Celtic Bank Corp. UT 1,586 $499
Ridgestone Bank WI 475 $474
SunTrust Banks GA 575 $365
Newtek Small Business Finance NY 391 $356
Seacoast Commerce Banc Holdings CA 325 $293
BBVA Compass AL 1,432 $269
Regions Financial Corp. AL 329 $247
BBCN Bank CA 315 $240
BankUnited Inc. FL 169 $207
Stearns Financial Services MN 490 $205

*Dollar amounts are in millions
Source: Small Business Administration

The top five 7(a) lenders in FY2015 carried their rankings through the first quarter of the SBA’s 2016 fiscal year as well, which ended December 31. Wells Fargo lead the group with 2,379 loans for total volume of $437 million.

Huntington SBA Group Manager Margaret Ference is a big proponent of the agency’s various loan guaranty initiatives, particularly the 7(a) program. “It allows us to invest in our communities and say yes” to small business borrowers who otherwise might be deemed too risky for a conventional commercial loan, she says. Whether the problem is a collateral shortfall, too much leverage or the need for a longer loan term than Huntington would normally provide, the SBA’s backing makes it possible for many small business borrowers to qualify for bank funding who probably wouldn’t be approved for a conventional business loan. “The SBA guaranty is used to mitigate risk, not to make a risky loan,” Ference says.

The 7(a) program is in fact Huntington’s primary small business loan, and the bank views it as an entry level product. The ultimate goal is to engage the borrower in a broader relationship that would include commercial deposit accounts, merchant services and cash management services. “That’s the start of a relationship,” she says.