The end of the year could produce an oversupply of loans as banks are forced to focus extra attention on cleaning up their balance sheets. “We are already taking calls from banks on this,” said one investor adding that “there is an expectation that mark-to-market pressures will intensify as the year-end approaches, especially for investment banks”.
According to an investment banker commercial banks will also be sellers going into the year-end, as a result of internal competition for capital. A key factor for banks this year will be the need to have capital available to recycle into new business as the withdrawal of central banks’ liquidity windows impacts on already strained balance sheets.
Adding to pressures are particular factors for certain banks such as UBS and Credit Suisse, which have been warned by the Swiss bank regulator to shore up their balance sheets, in a move likely to prompt assets sales. With a perception that there is no shortage of potential supply set to come, secondary markets have become moribund as cash sits on the sidelines.
According to a one loan trader, last week was among the quietest weeks of recent times in terms of volumes, though the US Labor Day holiday and a slow return from holidays probably accounted for some of that.
“Banks’ balance sheets are clearly going to be under pressure as year-end approaches, but don’t expect an enormous amount to pour out and it is not suppressing prices,” said the trader.
“Average secondary market pricing is being dragged down by the impact of out of favour sectors like retail and construction supplies. If you strip out those sectors the 30 or so names trading reasonably regularly are actually holding up in the 94/97 range,” he added.
Defaults on the up?
Low prices are also a response to credit considerations, reflecting the consensus that default rates will rise sharply, while a renewed focus on credit risk also helps to explain low volumes. Moreover, portfolio managers are already starting to see wider economic difficulties affect corporate balance sheets.
One restructuring expert said last week: “We are in for a long and difficult recession, we are already seeing plenty of waiver requests and are involved in restructurings of deals including recent vintage European LBOs.”
The inclusion of recent LBOs among deals being restructured suggests that default rates will begin to rise rapidly. Such deals need to underperform spectacularly to default, given the lax documentation and covenants on 2006 and 2007 signed transactions. Indeed many had predicted that the delayed feed through of underperformance in such deals would delay the statistical impact of underperforming LBOs.
Even if bank balance sheets do come under pressure the option is there for them to make targeted sales of large pieces of investment grade debt, without causing prices to plunge, rather than selling LBO debt piecemeal.
Though difficult to calculate, banks in general have less overhang LBO debt on their books that they did at this point in 2007 or at year-end 2007. So while not completely cleared, there is on the face of it a lower volume of potential outflows even if banks are forced to sell off leveraged loans.
Whatever the reason, the sense from the secondary market is of those investors with cash, waiting on the sidelines, with little real data to point to where the market will go. In that context even the perception that banks could become something akin to forced sellers in the coming months could be enough to keep that money sidelined.