New York, December 28, 2007 – (Reuters LPC) – The sub-prime contagion took the wind out of the loan market in the second half of 2007. But thanks to a very robust first half, loan issuance in 2007 edged up to a new record of $1.687 trillion.

In fact, the most beleaguered parts of the loan market – loans purchased by institutional investors, such as collateralized loan obligations (CLOs) and loans funding LBOs – enjoyed the greatest rise. Institutional issuance climbed past $425 billion, up 16% on a record 2006, while LBO lending topped $206 billion in 2007, nearly doubling the record posted in 2006. New issuance in the U.S. high yield bond market edged slightly down from 2006 and came in at $136.3 billion, a decline of less than one percent.

The first six months of 2007 marked the biggest bull market in loans ever. The symptoms of froth are almost too long to enumerate. Volumes soared: Deals worth tens of billions of dollars were mandated; institutional lending approached $300 billion in 1H07. Risk increased: Leverage on LBOs topped 6.5 times. Structure deteriorated: covenant-lite issuance surpassed $63 billion; second-lien issuance approached $30 billion; PIK-toggles were defended as a reasonable financing mechanism.

But the gaiety seemed forced; there was uneasiness as everyone knew the sub-prime debacle was gaining speed. The contagion spread into the loan market as the newly minted index for loan credit default swaps (LCDX) declined soon after sub-prime woes began to take a toll on the indices such as the ABX Series 6 BBB-, an index tracking a key basket of credit default swaps on high-risk mortgages and home equity loans. Starting June 6, the LCDX index began to decline, tumbling by nearly 840 bps to 92.11 through July 27. The shockwaves of the LCDX crash swept quickly into the cash loan market as loan prices declined. To make matters worse, the collapse of the sub-prime market burnt hedge funds that were both buyers of cash loans and of CLO. As cost of funding CLOs spiked, along with falling loan prices, the market seemed caught in a downward spiral. The timing could not have been worse given the forward calendar for leveraged loans was already above $200 billion, thanks to jumbo LBOs. Many of these deals were structured for a “pre-crunch” market and lacked key lender protections such as covenants. Appetite for these deals evaporated, forcing underwriters to postpone nearly $35 billion in loan sales, including a $12 billion loan backing the LBO of Chrysler’s auto business.

The market did see a period of recovery in the early part of the third quarter. This was further buttressed by the rate cut decisions by the Federal Reserve. Underwriters such as those backing the $29 billion LBO of First Data jumped on this chance and managed to sell nearly $10 billion of loans. The market rebounded into the fourth quarter, which gave underwriters another opportunity to sell significant pieces of other jumbo LBO loans, such as $13 billion in loans for Energy Future Holdings (TXU Corp.). But this sale marked the top of the market. Negative news on SIVs, oil prices and inflation served to remind the market that the sub-prime problem was far from over.

So how does the loan market move into 2008? Not particularly optimistically, a number of lenders say. A $115 billion institutional pipeline still needs to be absorbed. And there doesn’t seem to be a natural mechanism to quickly unstick the syndications machine. Having collapsed, CLO issuance remains hamstrung. Moreover, while the technical factors are difficult, default rates actually are quite low. If defaults climb, the situation could deteriorate materially.

League tables

Rank	Bank Holding Company	Volume	# of deals	Market Share
1	J.P. Morgan	$449,372,593,168	741	25%
2	Bank of America	293,393,467,960	833	17
3	Citi	280,455,334,471	356	16
4	Wachovia Securities	92,064,651,358	321	5
5	Credit Suisse	81,250,529,163	174	5
6	Deutsche Bank	71,748,433,853	109	4
7	Goldman Sachs & Co.	62,234,426,596	96	4
8	Lehman Brothers	46,235,382,679	77	3
9	Merrill Lynch & Co.	40,591,062,892	93	2
10	Wells Fargo & Co.	32,450,081,017	195	2

Rank	Bank Holding Company	Volume	# of deals	Market Share
1	J.P. Morgan	$148,988,173,255	285	20%
2	Bank of America	100,465,998,620	373	13
3	Citi	89,149,042,471	122	12
4	Credit Suisse	73,340,529,163	163	10
5	Deutsche Bank	44,868,433,853	82	6
6	Goldman Sachs & Co.	43,631,926,596	86	6
7	Wachovia Securities	36,463,695,308	157	5
8	Merrill Lynch & Co.	33,676,062,892	82	4
9	Lehman Brothers	26,905,182,679	68	4
10	UBS AG	20,692,403,419	76	3

U.S. Total Issuance	2006 Issuance ($Bils.)	2007 Issuance ($Bils.)	Percentage change (%)
Overall	1,672.50	1,686.80	1%
Investment Grade	721.3	657.6	-9%
Leveraged	612.1	688.5	12%
Institutional	366.1	425.8	16%
LBO*	112.7	206.5	83%
High Yield Bonds	137.1	136.3	-0.60%

U.S. Total Issuance	2006 Issuance ($Bils.)	2007 Issuance ($Bils.)	Percentage change (%)
Overall (new money)	762	838.9	10%
Investment Grade (new money)	219.1	209.3	-4%
Leveraged (new money)	412	471.8	15%
Institutional (new money)	274.1	315.1	15%

* Excludes bridge loans
**Includes only new financings, such as M&A, LBO, dividend payments, and incremental fund raising

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