Sharp discounts in the secondary market for loans continue to have a stalling effect on senior lending, particularly in the large market.
Sources said that a number of lenders with dry powder have started using it to buy loans on the secondary market, lured by the promise of returns in the high teens to lower 20s, rather than put it to work in new deals. However, if it seems too good to be true, it just may be. Many of the loans trading in the secondary market today are relics of the peak years, issued as part of highly levered deals with low pricing and light terms.
Leveraged loans are trading on the secondary market at some 70 cents on the dollar, as the traditional buyers of such debt products—collateralized loan obligations—have long since exited the market, leaving a void too large to be filled by opportunistic buyers, including buyout shops. That average represents a 25 percent drop from the 93 cents the same loans were trading at six months ago.
By way of example, senior loans for Energy Future Holdings Corp. (f.k.a. TXU Corp.), which at $45 billion represents the largest LBO in history, were trading between 66.75 cents and 67.50 cents at press time, while a similar loan related to
In light of mark-to-market accounting, lenders contemplating primary loans have to consider the price at which they’d be forced to hold them on their books, based on how similar loans are trading on the secondary market. Taking an immediate haircut on new loans is an obviously unattractive option. The dynamic continues to weigh on both deal flow and deal size. The number of LBO-backed acquisitions in 2008 is off 75 percent compared to last year, and there hasn’t been a deal announcement of more than $5 billion since July 2007, according to Thomson Reuters, publisher of Buyouts.
Deals being done today are levered at considerably lower levels than they were 18 months ago and the pricing on the leverage is much higher while terms are much tighter. “Given those characteristics, the deals that are getting booked nowadays are typically being done by people that are going to hold the paper. They’re not necessarily out trying to sell these things,” said Christopher Williams, senior managing director at Madison Capital Funding.
Some lenders go so far as to suggest that it may take an act of government to get the life blood of the LBO market flowing again.
At the Buyouts West conference hosted by this publication last month in Los Angeles,
“The main thing both debt and equity investors are looking from policy makers is consistency,” Schwimmer said. “When Treasury one day says the TARP will buy up toxic assets, then a month later completely abandons that approach, markets react negatively. The key is to pick a path and stick with it. That way investors and managers will know what to expect and can plan accordingly.”