The breakneck pace of primary issuance in the US and European leveraged loan markets slowed down considerably towards the end of last year. Opportunistic investors at the time had been keen to cash in on loans from the enormous LBO backlog, expecting that buying the most senior pieces of strong capital structures at discounts of more than 5% would yield windfalls. But price levels have continued to fall, and those same attractive credits are now offered at bargains of nearly 15% off. Portfolio gains on paper have been converted into real losses.
While these new lows might now be enticing bottom-feeder investors, they have also forced some highly leveraged loan investors to cash out of the depreciating assets, putting more downward pressure on the market and almost completely shutting out new issuers.
The halted general syndication of the buyout loan for Harrah’s Entertainment was recent evidence of the unforgiving market. The forthcoming sale of Clear Channel Communications‘ buyout loans, despite positive fourth-quarter earnings, could be the next jumbo buyout loan to suffer the same fate.
Many investors believe the secondary market could fall further, along with more margin calls and portfolio auctions. Because prices have declined so significantly, investors who own portfolios of leveraged loans as part of total return swap agreements or market-value CLOs, for example, have been faced with an ultimatum: sell loans or put up hard-to-come-by collateral. Last week, at least three portfolios were put up for auction, and there are more to come, investors say.
“You don’t want to catch falling knives now,” an investor said, rationalising his current passive stance in the market, despite last week’s rally (see High-Yield Wrap). “We had thought that maybe the market was looking better, but is it? We’re sitting around here waiting for the bottom. Some say it’s as low as 76, but I think that’s too low. How about 81?”
A look at some of the more actively quoted term loans, across a variety of industries, illustrates the way the market is trending. On November 16, HCA was quoted at 96.23–96.925. On Thursday, three months later, it came in to 90.769–91.615, according to Markit. In the same period, First Data went from 95.577–96.096 to 90.769–91.615, Ford Motor from 94.333–94.972 to 85.323–86-26. Michael’s Stores from 92.861–83.917 to 83.229–84.354, and Neiman Marcus from 96.698–97.521 to 88.313–89.583.
During that period the pricing of new CLOs, which had been the market’s lifeblood, ground to a halt and the many new investors that sought to replace them, such as bond funds, found remorse not returns.
“CLOs are basically dead,” said the investor, who manages several CLOs. “The only support the market had was coming from bond buyers last year and possibly opportunity funds. But [they] got burned and they have already or are now trying to unwind those investments. That’s affecting the market. All the non-CLO buyers are dumping paper.”
Nowhere to hide
A bond trader concurred. “I’ve seen a lot of guys who were negative on the bond market – many hedge funds – and thought they could hide in senior loans, and their strategy has backfired on them,” he said. “This was big at the end of last year and even early this year. They got sucked into loans at 95 – that seemed very cheap.”
In Europe, they are also feeling the pain. The secondary market there has seen a sharp fall since June, struck by problems similar to those in the US.
David Slade, managing director and head of the European syndicated loan group at Credit Suisse, was blunt. “Conditions are dreadful. The secondary market is moving further away from credit fundamentals to technicals,” he said at last week’s S&P European Leveraged Finance Forum. “TRS lines and market value funds have seen dramatic unwinds. Rumours can knock five points off names. Some institutions have shorted the market, which is exacerbating things.”
Arrangers and investors tend to agree that the problem in the market is not with the underlying credits. However, that does not mean anyone is rushing to get a piece of the market.
“Non-traditional loan investors are attracted by the returns available in this market, but people are concerned with the technicals, many feel there could be another round of falls to go,” said Stephen Byrne, managing director and loan trader at Goldman Sachs.
There are buying opportunities in Europe, but investors need to be careful. “The market should be a buy – provided you select the right credit,” said Ian Hazelton CEO of Babson Capital. “We are not scared of bank credit and on the face of it, high 80s prices look like good value, but the question is, ‘Where will it be next week?’ Loans right now are better relative value than high-yield bonds, maybe even then higher rated bonds.”
The only way the secondary loan market can rebound substantially is by finding a new group of investors to invest in CLOs, or finding another vehicle to work to stabilise the secondary the way CLOs did.
One CLO manager was pessimistic, expecting a downtrodden loan market for the rest of the year. “There are no reasons for optimism,” he said. “I’d like to do another [CLO], but there’s no capital for them. New CLOs got their AAA funding from SIVs, which got into trouble in the sub-prime crisis. There’s no one to replace them. It’s dead. It’s rotten to the core.”
Another investor explained that there had been some interest from institutions such as endowments and pension funds. “That’s the bid we’re looking for,” he said. “Somebody’s got to take the place of the SIVs.”