Europe's PMs Favor Cheap Secondary Loans
September 25, 2008
The bolt from the blue that was Lehman Brothers/Merrill Lynch has only further enhanced the year’s ongoing trend in the European leveraged loan market: the attractiveness of the secondary market over the primary.
Naturally, loan prices were smashed by the events of the past couple of weeks, but they had already been low prior to the mess, having fallen slightly over the previous weeks from the gains seen in the early part of the summer. Last week, sources said, the average price of loans in the secondary was 84, a point below the February low of 85. As such, investors still believe that the secondary is the place to find loan deals, if they’re going to invest in loans at all, and this will make it harder for new primary deals to price.
“I see little point in buying primary loan deals at the moment,” said a European leveraged loan fund manager.
While deals have been launching fairly steadily on the primary, this manager believes that pricing is still quite ad hoc and the primary market has yet to find a proper price floor to justify purchasing credit there.
“There’s no real benchmark for the primary, and I’d rather do the work and see a deal break in the secondary, even if I lose a point or two,” he said. “Right now, leaving yourself to the mercy of a lead manager to see where a deal would price is pretty dangerous.”
Adds Nick Atkinson, head of European leveraged finance at RBC in London, “If you speak to any banker right now and ask for a stab at what the pricing is, you’d get totally different answers.”
Because of the availability of credits at attractive prices in the secondary market, it can be hard to convince investors of the merits of primary deals, Atkinson said. “They tell us, ‘Why should I do something in the primary when I get €10 million of something similar in the secondary at a 10% discount?’”
The only argument bankers have, Atkinson said, is to point out that new primary paper is far less levered than the paper already on the secondary, and that fresh deals have proper covenants in them. Not many investors, however, are buying the argument.
Still, it’s important to note that the secondary market in Europe, albeit attractive from a price point of view, is extremely illiquid, Atkinson said. Bank lenders buy to hold, and the institutional investors and hedge funds that were playing the market during the good times are now gone. “Prices can move on one trade alone, and the secondary market for leveraged loans in Europe is really like a shop window, with lots in it but no one in the shop,” he said.
Indeed, “secondary trading volumes have been and continue to be very thin,” said
Charlotte Conlan, head of leveraged syndications at BNP Paribas. “And for those who want to buy, it is hard to find paper without moving the price against the buyer.”
With many investors having already topped up in their preferred credits, new capacity from portfolio sales in the widely-traded flow names will, not surprisingly, depress prices, Conlan said. All the same, she believes that banks, funds and CLOs are indeed interested in new deals, but clearly only if they come with the right structure, leverage and acceptable pricing—and this is a moving feast.
“Identifying the necessary parameters to ensure liquidity is the most difficult it’s ever been, but for the right deals appetite will be there." Conlan said.
Over the summer, BNP Paribas successfully launched loan financings for two German companies: A €500 million deal for the buyout of truck manufacturer Jost and a €415 million deal for the buyout of the manufacturing concern Stabilus.
While managers say more deals are slated to come to market before the end of the year, investors remain leery of the debt overhang that continues to clog up banks’ balance sheets, and the impact of this on new lending.
“We won’t be able to find a primary flow until banks clear up the backlog,” the loan fund manager said. “The leads are going to be talking up the market, though, so there will be a smokescreen for a while.”
As far as the secondary goes, it’s likely that distressed investors will come into the market and buy at the very low end. This will provide some support, the manager said, and eventually allow for an uptick in prices across the board—although whether that will be enough to elicit more interest on the primary side is yet to be seen.
And of course, there is still an enormous amount of uncertainty in the global financial system. While markets—including the European leveraged loan market—did initially rise after the announcement of a $700 billion bailout package for U.S. financial institutions, they once again fell last week as participants all over the globe digested that package. Clearly, this has underscored the great volatility that will continue to stir up all markets.
“Banks that we knew in one way yesterday are going to look different tomorrow and as they double up in names. That’s going to have an impact on the secondary market,” Atkinson said. “The long-term impact of the bailout will also have an impact on the secondary market, so we are in for a very volatile time.”
Lehman Brothers last Tuesday was reportedly replaced as agent on two European leveraged loan financings it underwrote last year: The senior debt tranche of a £450 million financing backing the buyout of U.K. forging industry manufacturer, Firth Rixson, and a €1.1 billion loan that backed frozen food manufacturer Iglo Birds Eye Frozen Foods.
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