The leveraged loan market’s performance hasn’t quite lived up to expectations so far this year, but participants are predicting that issuance will pick up strongly in 2013. It is possibly pushing outstandings to a record level, according to a survey conducted among members of the Loan Syndications and Trading Association (LSTA).

Survey respondents also expect two important buyers of loans, CLOs and loan mutual funds, to boost their assets in 2013.

That’s not exactly going out on a limb in terms of CLOs, which have been on a tear this year, but it would be a welcome change for loan mutual funds, which are marketed to retail investors and have struggled to attract new money since the Federal Reserve indicated last year that it would keep official interest rates low indefinitely.

“Survey respondents are generally optimistic about market conditions next year, as they expect both supply and demand to increase,” commented Bram Smith, executive director of the LSTA.

At the end of August, outstanding institutional loans in the Standard & Poor's /LSTA Leveraged Loan Index were just shy of $530 billion. That’s several billions of dollars short of the level LSTA members predicted for the end of this year in a survey conducted last year.

Nevertheless, respondents in the latest survey, which was conducted over a three-week period in August, expect total outstanding institutional loans in the S&P/LSTA Leveraged Loan Index to reach $550 billion in 2013.

A significant percentage of the 296 respondents, 17%, think it will finish even higher, at $600 billion or more, which would be a record.

The forecast for leveraged loan issuance is mixed. Issuance of institutional loans, which are syndicated to CLOs, mutual funds, pension funds and other institutional investors, is expected to pick up in 2013, putting it in the range of $225 billion to $250 billion.

While issuance of pro rata loans, which are syndicated only among banks, has been stronger than expected this year, survey participants forecast it will be also be in the range of $225 billion to $250 billion in 2013.

Institutional loans typically have a tenor of seven years, one–year longer than the typical pro rata loan. Investor demand is also expected to increase next year.

Forecasters are predicting CLO issuance to reach $32 billion this year; this may be an easy target as CLO issuance has totaled more than $25 billion year-to-date, more than the past three years combined.

CLO issuance is expected to total $36 billion next year, with a noticeable minority of respondents, 11%, thinking issuance will reach at least $50 billion in 2013. Additionally, assets under management in loan mutual funds, another key source of demand, are expected to climb to $82 billion in 2013, and fully 25% of survey respondents think loan mutal fund assets will top $90 billion by the end of next year.

Survey respondents continue to believe the biggest threat to the loan market this year is the ongoing European financial crisis. More than two-thirds of respondents, 68%, listed the crisis as their biggest concern. But regulation catches up with Europe as the biggest concern in the coming years. Thirty two percent of respondents cited regulation as their biggest concern in 2013, while 31% mentioned the European crisis.

“While loans and CLOs performed extraordinarily well in the financial crisis, many of the new regulations will inadvertently stifle lending to U.S. companies in the coming years,” Meredith Coffey, executive vice president of the LSTA, said. “This is leading to increasing concern amongst lenders.”

Defaults are expected to remain benign in 2012. While they will probably climb modestly in 2013, they should remain well below the long-term average. Respondents forecast a default rate of 1.75% next year, up from one percent currently. Just 6% of respondents think defaults will rise above 3%. In the secondary loan market, trading volume is expected to rise, climbing past $420 billion next year, up from $390 billion over the last 12 months.

Reflecting investor demand for loans, the average bid, 95.5, is significantly higher than respondents were estimating last year. Survey respondents expect bids to continue climbing with 23% of respondents forecasting bids will be 97.5 or higher by the end of 2013.

Issuance of investment-grade loans and loans to small and medium-sized companies have both fallen short of expectations this year, but, survey participants expect issuance to recover in these two sectors in 2013. They had originally predicted issuance of middle-market loans would reach over $190 billion this year, but to date volume is around $160 billion. Nevertheless, the forecast is for issuance to reach between $175 billion and $180 billion in 2013.

Issuance of investment-grade loans stands at around $555 billion year to date, compared with expectations for over $750 billion; still, survey participants are calling for volume to top $600 billion in 2013.

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