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Opinion Credit matters
Firms worried about regulatory scrutiny may breathe a sigh of relief
by Lisa Lee
Lisa Lee
Deputy editor
Creditflux
The second Trump presidency is likely to turbocharge already frothy markets
Donald Trump has decisively won the US presidential election. The impact of Trump’s second term in the Oval Office will be wide-ranging for the US and the world. For credit markets, his return to power portends more intense competition between banks and private credit, and frothier deals.
Financial conditions were already remarkable going into what may prove to be the most consequential election of our times. The S&P 500 was returning almost 22% and the Dow Jones Industrial Average was up about 12% for the year until 5 November. Capital markets were wide open — so much so that investment bankers closed on a record amount of US leveraged loan deals, including repricings, and were on pace to arrange a historic number of CLO transactions.
That’s all about to burn even hotter if history is any guide. Private credit firms worried about regulatory scrutiny may breathe a sigh of relief. Global banks trying to lighten assets with toughening risk-weighted capital requirements may rethink the move. And the duo’s battle to win financing deals — and earn princely fees — may heighten.
Lessons from last time
Before we look to the future we should take a quick look at the past. The last Trump administration changed the rules of the game in the leveraged loan market that had been put in place after the Great Financial Crisis. The Interagency Guidance on Leveraged Lending was a response to banks getting stuck with more than USD 200bn of underwritten junk debt after market conditions swiftly turned during the early part of the crisis. While the hung debt didn’t cause the demise of any bank, it definitely contributed to their struggles.
From 2013 to 2017, regulators handcuffed investment banks’ work as the middle man between issuers that borrowed and the investors that bought the debt. For example, banks could get slapped for arranging a debt financing that exceeded 6x debt-to-EBITDA.
Famously, federal regulators criticised a Morgan Stanley-led bank group of Goldman Sachs, Barclays and Citigroup over how they dealt with a USD 1.15bn loan raised for Uber Technology in 2016. Though the car share service had an enterprise value far above the loan value, Uber was burning cash to fuel its growth and had no EBITDA to speak of, thus running afoul of the guidance in the view of the Obama administration.
Once the Trump administration took control, Treasury and other officials tacitly allowed investment banks to breach the leveraged lending guidance. Soon enough, the market was seeing 7x leverage and 8x leveraged loan deals. Then regulators explicitly defanged the guidance, with help from Congress. By the time Elon Musk came to the leveraged loan market to boost spending on SpaceX and then to back his buyout of Twitter, the bright line of 6x leverage limitation was far behind.
Banks, however, still hewed to a certain tone. Fearful of upsetting regulators, they proactively try to get ahead of oversight and have kept their financing deals under 8x. While that figure could be juiced by earnings adjustments, the constraint provided an opening for the newest lending upstarts: direct lenders.
Fast forward to the present. For the last few years, banks have been on the back foot. The titans of private credit have raised gigantic sums and are winning deals even after the capital market opened last year. They are able to offer PIK, put on more leverage, and do ARR deals for cash-negative start-ups. Already investment banks were responding by selling loans with more leverage, looser documents to protect lenders, and tighter caps to protect themselves against market volatility, according to market sources.
That could be turbocharged. JPMorgan was considered an outlier when it deployed USD 10bn of its balance sheet to compete against direct lenders, disregarding the painful capital charge for holding such loans. Other banks may now ape it. Leverage on financings could creep even higher, documents weaken even further, and PIK toggle notes, a creature of the early 2000s, could return.
On the private credit side, there wasn’t much fear over future regulatory oversight. Certainly, borrowers weren’t noticing any constraints despite the noise over differing valuations of loan holdings, or the rise of PIK debt. But according to a recent study — Where Do Banks End and NBFIs Begin?, by the Federal Reserve Bank of New York — banks were increasingly interweaving into private credit risk, with both funding each other. Regulatory oversight over that behaviour may have concerned banks — but less so now.
The convergence of the syndicated high yield bond market with leveraged loans and direct lending has been a trend of the past few years. The Trump presidency is poised to accelerate it.
