While all eyes have been fixed on the interbank market, and the plunge in the Baltic Dry Index has also garnered some attention, the sudden decay in the loan market (meaning for the most part leveraged loans, the sort used to finance LBOs) has gotten far less commentary. Yet this will wreak havoc on bank balance sheets, as it did last year. Banks have gone to some length to try to reduce their loan inventories, even going so far as to finance sales heavily. But values have continued to erode. Loans were recently trading in the mid 80,. Some contended those prices were suspect, on small volumes to cooperative counterparties.
The cynics’ view appears to have been borne out by the price plunge last week as recounted in the Financial Times:
Investors in European and US loan markets will enter their offices with great trepidation on Monday morning after a flood of forced selling by hedge funds and other leveraged investors sent prices crashing last week.
In Europe, the average price of the most commonly traded large leveraged loans to companies such as Alliance Boots, Ineos, NTL and United Biscuits saw its biggest weekly drop, according to S&P LCD, the market information service, and Markit Group.
The US market for such debt, which is mainly used for private equity buy-out deals, has also suffered big falls in recent weeks as hedge funds and other market value sensitive investors have become forced sellers.
Analysts do not expect the picture to improve in the near term because falling prices for loans and other risky assets lead banks to force hedge funds and other investors who use borrowed money to put up more cash in so-called margin calls or sell holdings…
“A vicious circle of redemptions, margin calls and further redemptions can only make us nervous on [loan and credit] spreads in the short run,” said Peter Goves, Citigroup strategist. “While funds in equities probably have plenty of cash on hand at this point to cope with redemptions, in credit we are not so sure.” He added that a normalisation in loan and credit markets was only possible once so-called real money – or non-leveraged – investors saw value in such stressed prices no matter how bad the economic outlook.
The US loan market saw its worst losses nearer the start of October, when the price of loans to companies such as Celanese and Charter Communications dropped from more than 90 cents in the dollar to the low 80s and the high 70s respectively in a matter of days. Loans to Ford Motor have dropped from 65 cents to 42 cents this month, according to data from Markit.
Investors put out requests for bids on portfolios of loans worth $2.28bn this month alone, according to S&P LCD, which compares with a total of $471m for all of the third quarter.
In Europe, the average price dropped 7.2 cents in the euro to 73.32 cents according to S&P LCD, more than double the previous week’s decline and the biggest weekly drop yet seen.