Leveraged Loans May Get More Scrutiny If Democrats Win House

(Bloomberg) -- If the Democrats win the House in the midterm elections, U.S. loan market participants worry that regulators may sharpen their focus on riskier deals, which will result in a decline in issuance. The health care sector may benefit from the ensuing gridlock because it would reduce the possibility of regulatory changes.

Regulatory Comeback

  • Leveraged lending guidance, which fell by the wayside under the Trump administration, could see a comeback -- or at least not loosen further -- if Nov. 6 is a good day for the Democrats
    • "If the Democrats do win the House and/or the Senate I would expect them to cause gridlock in Washington and generate more noise around enforcing some of the regulation that was enacted during the Obama administration, specifically the leveraged lending guidance": John Sherman, portfolio manager at DDJ Capital Management, which has $8.6 billion in AUM
    • If regulations are reenacted "that would likely decrease some issuance for the market and could potentially slow down some of the M&A and PE-backed lending": Sherman
  • The regulatory landscape was also on the agenda at last month’s LSTA annual conference
    • "While the regulatory environment is relatively benign now, the coming midterm elections or exogenous events may lead to dramatic change," the LSTA said in a write up of its Oct. 24 event
  • However, BlackRock doesn’t expect Democrat House win/Republicans retain Senate outcome to affect regulation
    • Sees "low risk of rollbacks to the administration’s tax cuts and regulatory policies in the short term": BlackRock said in Nov. 5 note
  • The Federal Reserve last month warned Wall Street banks about doing increasingly risky loan deals

Read more: Republicans Keeping House, Senate Is Risky for Bonds, Says BlackRock

Health Care Gridlock

  • Health care issuers could benefit from the election, particularly if there is a stalemate if Democrats gain more power
    • "Gridlock is positive for health care because you wouldn’t see change on either side and it would bring stability on the regulation front": Sherman
  • The fate of the Affordable Care Act and its impact on companies in the industry hinges on the outcome of the election; health care is one of the biggest talking points of the lead up to voting
  • Health care borrowers account for $72.2b, or 10% of issuance in the U.S. institutional loans market YTD, the sixth largest industry, according to data compiled by Bloomberg

Read more: Junk Bonds Poised for Post-Midterm Election Boost, Says Wells Fargo

Removing Uncertainty

  • Moving past midterms means loan investors will have one less thing to worry about, said Michael Marzouk, portfolio manager at Pacific Asset Management, which has more than $5 billion of loans under management
    • "Getting it behind us usually is a positive as it removes the uncertainty": Marzouk
  • Of the four possible outcomes -- Republicans retaining both the House and Senate, the Democrats winning either the House or the Senate or Democrats winning both -- none is particularly worrisome for the leveraged loan market
    • "Under each of those scenarios, we don’t see much volatility": Sherman
      • "Loans have been a relative safe haven due to their seniority in the capital structure and floating rate coupons"
  • Rates may be headed higher as the benchmark nears a seven-year high

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