On Wednesday March 16, Versana, a new fintech backed by four of the world’s largest banks, became the latest company to declare its ambition to use digital technology to bring new efficiency to the still largely analogue and slow-moving private market in syndicated loans.
It is a large market, today worth roughly $5 trillion, and likely to grow even bigger in the years ahead. That is because syndicated loans pay a floating rate of interest, protecting lenders, including a growing array of institutional investors alongside the traditional banks, against the losses rising rates are now inflicting on fixed-rate bonds after their decades-long bull run.
Euromoney wonders if it is entirely a coincidence that its founders unveiled Versana on the very day the US Federal Reserve finally increased by 25 basis points its target range for the Federal funds rate.
Making the loan market more efficient and transparent should make it more liquid and attractive to new participants
This first hike since 2018 may be followed by six more this year, with the market now pricing in three additional increases in 2023.
And if those higher rates bring forward a recession, then owners of floating-rate syndicated loans will comfort themselves that their holdings are often secured against borrowers’ assets and come with covenant protections that place them at the top of the risk-capital stack, in a senior position to most bondholders.
With the primary high-yield bond market all but closed since the start of the war in Ukraine, leveraged loan investors will be feeling a little better hedged.
“Making the loan market more efficient and transparent should make it more liquid and attractive to new participants,” Cynthia Sachs, chief executive of Versana, tells Euromoney. “But the only way to do that is if the whole market – banks, institutional lenders and their service providers – come together.”
Sachs started her career in origination at Bank of America, worked as a portfolio manager at Natixis for what was effectively an on-balance sheet CLO and later as a trader at Morgan Stanley. After the global financial crisis, she moved into technology at Bloomberg, setting up its evaluated pricing service, before more recently heading a Carlyle-backed art finance startup. She describes this latest role as her dream job.
Errors
Loans are non-standardized. And this is a pre-payable asset class. The leading agent banks may have to transmit frequent messages sometimes to several hundred investors in an individual loan, perhaps on an early amortization or a proposed covenant amendment. Investors may often input this new data manually into their own position monitoring systems, sometimes creating errors that then require more queries back to the agent banks and reconciliations.
It is not straightforward. Most old loans were written with margins over three-month Libor and are transitioning onto Sofr (secured overnight financing rate). Interest is usually paid quarterly. Investors can’t be sure exactly what interest payment to expect, based off overnight rates, that has supposedly been accruing over the preceding 90 days.
Our industry sits at the crossroads of global banking, private equity, asset management, insurance and private wealth, and yet we haven’t seen the digital transformation that has come to other parts of the capital markets
Lee Shaiman, executive director of the Loan Syndications & Trading Association (LSTA), says: “Our industry sits at the crossroads of global banking, private equity, asset management, insurance and private wealth, and yet we haven’t seen the digital transformation that has come to other parts of the capital markets.”
Sachs has seen it all and talks through a typical challenge.
She says: “Most credit funds manage to zero cash. If they see an attractive opportunity to buy a new loan, they may look to sell an existing asset in their portfolio. But say a borrower gives notice to the agent bank of an early, unexpected prepayment. Versana will capture that event and, with a permissioning system that grants investors access to data only on loans they hold, deliver notifications in real time via API [application programming interfaces].”
Now, rather than sell something to make room for a new position, the portfolio manager can instead use that prepayment to buy the new asset.
Other people have spotted the glaring inefficiencies in primary and secondary loan markets that make this an asset class that can settle on trade date plus 20 days while the rest of finance is at T+2 and could go to T+0.
Credit Suisse was an early adopter of blockchain technology in loan markets, encouraging other banks onto its Synaps system for sharing digital data to avoid manual inputting from faxes and emails in multiple formats.
Various French and UK banks later joined forces on LenderComm to do much the same thing.
But the inefficiencies remain.
Future proof
Maybe those innovators were too eager to embrace distributed ledger, using R3’s Corda platform even though it then required bridges into banks’ main enterprise technology. Perhaps this was too disruptive.
“We want to future-proof our technology and we believe in interoperability,” Sachs says. “Blockchain could be the future, but the basics come first. Loan-market participants want to have a full grasp of their cash flows, that is on money coming into and flowing out from their loan portfolios. Getting data digitally and transparently, in real time, from the agent banks’ source systems of record has never been done before in this market.”
Versana uses cloud technology and APIs, and is building a technology stack, with help from its founding banks, that could link to blockchains but without starting on them. It will launch its platform in the second half of 2022.
What gives it every chance of success is the identity of those founders: JPMorgan, Bank of America, Citi and Credit Suisse.
The inner circles of the loan market have been buzzing for months with rumours of this initiative, which, as Euromoney understands, was first conceived inside JPMorgan.
The lead bank in the syndicated loan market then brought in its closest competitor. Between them JPMorgan and Bank of America arrange 20% of all syndicated loan volumes globally.
Add in Citi and then Credit Suisse, the third-ranked arranger of leveraged loans – the market in which institutional investor participation is most developed – and the founding banks between them arrange between one quarter and one third of the entire market.
Dan Wilkening, chief administrative officer Commercial Banking and head of Global Services at JPMorgan Chase, says: “We’re proud to be a leader in transforming the industry’s syndicated loan market. There’s been rapid acceleration in this market, and with Versana, we’ll be able to make loan data available to our clients more efficiently and transparently.”
By the end of the day on which the company was finally named, Versana already had more banks applying to join.
Alex Naboicheck, head of US leveraged loan trading at Bank of America, says: “We saw an opportunity to spur innovation in the loan market and joined with other leading agent banks to form Versana. By addressing many of the challenges inherent in the industry, the entire loan community will benefit.”
Versana will first focus on the US institutional part of the loan market, known as the term loan-B market.
Sachs says: “From there, we will look to expand into other types of facilities, like revolvers, into middle-market loans, and internationally into the Canadian and European loan markets.”
It may be that the biggest cost savings will flow first to the agent banks themselves. Greater operating efficiency may reduce risk capital and so boost returns.
And there is another group that could benefit.
Sachs says: “We think institutional lenders will be impressed with our platform and the operational efficiencies it will create. If that can help bring more participation into the loan market, meaning more assets under management for credit shops to manage, than that should ultimately lower the cost of capital for our borrowers.”
In the new era of rising rates, quantitative tightening and, for some, uncertain access to the primary bond markets, that will be welcome.
