Despite a difficult childhood, the secondary loan market came of age in 2003. Growing liquidity and then a lack of supply led to a frenzy for paper. Adam Harper reports.
The £950m acquisition loan for Taylor Woodrow was exactly the kind of paper that the secondary market was looking for as supply began to dry up in November. With a margin of Libor plus 105bp out of the box alongside BBB+ investment grade quality, investors got on the phone to HSBC asking how much paper they could buy.
But there was none to be had. The deal achieved a 100% hit rate at the sub-underwriting stage and did not progress to general syndication. The paper was tightly held by the sub-underwriting banks, which had been scaled back and were looking to top up themselves.
When Yell’s refinancing, a UK deal of similar size, hit the market in early September, a minority of traders expected the paper to trade outside fees because they believed the sub-underwriters were long on their target holds and would overload the market as they looked to reduce exposure.
But they were proved wrong. A steady supply of Yell paper was received enthusiastically by investors — the dealer market price rose from a 99.40-99.55 context to about 99.80 in four weeks. “It’s often a case of feast or famine in the secondary market,” says David Fewtrell, director and head of loan trading at HSBC in London. “There’s either huge demand and no paper or everyone’s a seller but no one wants it.”
Last year was indeed a story of gluttony followed by hunger for secondary traders and investors. Up until July, the market enjoyed healthy levels of liquidity. But a lack of attractive assets coming through from the primary market and the cancellation of many loans brought the market close to a standstill as year end approached.
Among others, the market lost Eu5.4bn in Olivetti term loans after they were repaid; Spanish utility Endesa paid down early; Cadbury Schweppes retired part of its $6.1bn loan; the Deutsche Telekom ‘B’ tranche matured in October and was not renewed; and pub chain Mitchells & Butlers was no longer available to trade. And to make matters worse, with the dearth of event driven financings, new assets did not emerge to take their place.
“The lack of issuance means the major lending houses have not been as active in portfolio management — they’re crying out for assets themselves,” says Gordon Craigen, managing director in loan trading and sales for CIBC in London. “Luckily, the first seven months of the year were busy and most desks were able to make some money, largely through spreads tightening on the telecoms names.”
Traders might be forgiven for panicking as a series of the most familiar names bit the dust. But Stephen Snizek, director of loan trading at Deutsche Bank in London, is pragmatic. “Am I concerned? No, it’s part of life,” he says. “By definition, acquisition facilities have short dated tranches and their quick disappearance should be priced into the market.”
As supply dried up in traditional flow names, trading desks looked to more esoteric names in the hunt for profits. “We are pursuing opportunities where we make a return on one trade that we would make on five flow trades,” says one prominent head of secondary trading. These deals tend to realise whole percents rather than basis points in profit and are usually conducted quietly.
Traders believe there has been value in LBO paper issued over the last six to 18 months. “You couldn’t find a bid for Demag, Jefferson Smurfit or Legrand six months ago — now they are near par. It’s either a sign of investor confidence or a lack of issuance,” says Stan Sokolowski, head of loan trading at JP Morgan in London.
On the cross-over corporate side, HMV Media paper has risen from a low of 88.00 to 97.50. Traders say that even greater gains have been made in the true distressed debt market.
The aridity of the market means that participants are having to work harder and take more risks to secure returns. The days of riskless trading — where dealers find a retail investor before buying themselves, and passing on the asset for a healthy profit — are over, says Deutsche’s Snizek. “Until more traders put up capital and take risks, it will be very difficult to build the market without new issues. The easy trades are no longer obvious — there are still profitable trades to be made, but they are no longer two phone calls away.”
An increased number of participants is making life even harder for the dealer market. Most arranging houses have at least one person focusing on the secondary market. But the amount of names quoted and immediately available on a two-way basis is small. “The issue is not whether I can get liquidity in France Télécom, but whether I can get liquidity in a less traded name,” says Snizek. “That is where the number of providers narrows and needs to grow.”
Although one trader with eight years’ experience describes the latter part of 2003 as the quietest he has ever seen in the secondary market, many see it as a positive year overall. The Loan Market Association recorded volumes of Eu25bn for the first half of 2003. A London head of secondary trading says volumes dropped off, particularly in the fourth quarter, but estimates that the par/near par market will have grown by 10%-15% last year.
Estimated Secondary Market Loan Volumes, 1998-2003 (eu Bn)
Source: Loan Market Association
Some traders also believe the market proved its depth and liquidity when Dresdner Kleinwort Wasserstein’s Institutional Restructuring Unit (IRU) auctioned off a Eu511m portfolio of non-performing loans in May.
They are also encouraged by the emergence of a second inter-dealer broker in the market. Tullett Liberty hired Bobby Console-Verma as head of credit products in November, providing some competition for GFI.
The secondary market is having a greater impact on the way deals are structured in primary, says JP Morgan’s Sokolowski. “Syndicate guys ask how names and sectors trade. The secondary price is considered alongside bond and credit default swap prices, ratings and the amount of ancillary business on offer — it has an influence on primary pricing.”
Nonetheless, the market remains in urgent need of new assets if it is to grow further.