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

        --With assistance from Jeannine Amodeo.

        To contact the reporter on this story: Kelsey Butler in New York at kbutler55@bloomberg.net

        To contact the editors responsible for this story: James Crombie at jcrombie8@bloomberg.net, Faris Khan, Christopher Maloney

        ©2018 Bloomberg L.P.

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