Evolution of the Syndicated Loan Market
In our latest insight article, David Morley takes a look at the Syndicated Loan Market and reflects on recent impacts and potential future developments.
The syndicated loan asset-class has been impacted significantly over the last couple of years by higher interest rates. Higher rates have weighed heavily on the financing costs and this, combined with global and political uncertainty, has led to both borrowers and banks taking a more cautious approach.
Private Credit Gains Market Share
As banks have stepped back from riskier lending, this has allowed private credit firms to gain a significant market share of direct lending. These firms were willing to offer much more tailored loan structures, which has seen increased demand through a period of higher rates.
The private credit market is now estimated to be in excess of $2 trillion and growing rapidly. Banks have responded to this by entering the private credit markets themselves, either by setting up their own credit funds, or by co-operating more closely with third party private credit firms. This partnership can take a variety of different forms e.g. offering hybrid syndication structures, using wealth management divisions as a distribution channel, or implementing significant risk transfers (SRTs) in order to access investors.
Going forward the syndicated loan market and the private credit markets are increasingly being seen as complimentary. Borrowers will choose to access either market depending upon their preferences. The traditional syndicated loan market will provide more competitive pricing versus the higher certainty and speed of execution in the private credit market.
Not so fast…
In spite of the growing size of the asset class, the loan market still has a number of operational inefficiencies. As the public securities markets march towards T+1 settlement (the US is already there, UK and Europe to follow in 2027), the leveraged loan market still operates with significant settlement lags. The latest LMA data has the average par loan settlement at T+38 (in the US the latest LSTA data is T+15).
The main reason given for the lengthy process is the need for KYC, not only between the trading counterparties but also by the agent bank for the buyer. This is not helped in the European loan market by the lack of standardised transfer language and the need to obtain borrower consent for certain facilities. The settlement process still relies on confirmations being drawn up, reviewed and signed by the counterparties; together with transfer documentation signed by the counterparties and the agent bank.
There is also no market-wide matching process so identifying missing trades can create delays leading to heightened operational risk. Given the impact of unsettled trades on a bank’s balance sheet and capital, significant trading volumes can lead to issues at quarter end requiring banks to deploy additional or surge capacity.
Adding to the operational inefficiencies, post-trade processing of loans also still includes many manual steps, for example: the receipt of information from agent banks and the reconciliation of positions and interest receipts/payments. The processing of corporate events such as voluntary paydowns and voting intentions can also be time consuming and additional complexity is added when loan trading is done from the public side, as loan information is largely considered private.
Potential for Automation and Efficiency
Given the manual nature of a number of the loan operational processes, the case for increased automation would seem obvious. There have been some successful workflow tools that have been around for a while now e.g. Clearpar for confirmation and transfer documentation; and we are now seeing more applications being adopted amongst the larger players. Examples of these solutions include Octaura on the trading side and Versana on the agent side.
However, the rate of adoption amongst the wider market is still not as widespread as expected and I believe that are several likely reasons. Firstly, inertia. The loan market has operated on a largely manual process basis for a long time and people are comfortable with that. From my experience overseeing a loan closing function for over 15 years, I can count on one hand the number of trades that failed (even though some trades took literally years to settle), so although slow, perceived operational risk from failed settlement is very low.
Secondly, cost is an important factor. The market has worked with the current manual processes for some time and adopting the latest solutions and integrating them into the institution’s existing platforms is expensive. Given the cost targets that most banks have been operating under in recent times, upgrading loan systems has not been a high priority within a restrictive budget.
Finally, loans are not deemed securities and so subject to a lot less regulation. As such there has not been the same pressure from regulators to get settlement processes fixed as there has been with other financial instruments, such as OTC derivatives. So while the major players will push ahead, it may be quite a while yet before the wider market takes full advantage of the automation available.
Conclusion
Syndicated Loans will be an interesting space to watch further over the coming years. Private credit firms have already shown how easily market share can be pulled from main stream banking, especially with increased complexity and a need for more rapid solutions. It’s good to see that some banks are taking initiative and making changes in order to remain competitive, however, will those that don’t make the investment available fall by the wayside as the market evolves further?
Author: David Morley – Board Advisor and US Business Lead
Jan 2025