Trading in second-lien loans is becoming increasingly difficult as the spreads on some of the loans are perceived as too narrow. Traders and investors alike said they expect to see new second liens struggle to get wrapped up in syndication and increasingly trade under par.
Traders are anxious to see how Targus International's second lien does when it breaks for trading. The second lien, which is being put in place after leads Goldman Sachs and UBS scrapped a planned bond offering, is part of a package financing Fenway Partners' buyout of Targus International from Apax Partners. Syndication of the piece launched late last week, so it could not be determined how it was going by press time. One trader said he was not optimistic that it would trade well. He cited San Juan Cable as a second lien that recently broke under par and is now trading the mid-99 range. "Because second liens are trading down, nobody wants to buy them," he said. Spokesmen for Goldman Sachs and UBS declined to comment.
Investors are becoming concerned about the real recovery rates of second liens in the case of default. There is a growing sense that the market may have overestimated the recovery values on these loans. Stephen Moyer, director of research at Imperial Capital, a boutique investment bank focusing on high yield, bank and convertible debt, warned that the explosion in the second lien market will lead to a lot of volatility because they are under-collateralized. "Many have been issued on the presumption that they are well collateralized," he said. "We will see many situations where they are not well collateralized. The second-lien market will be the next shoe to drop." He added that second-liens that are trading at par and that are deemed to be unsecured will trade to where unsecured bonds are trading, at a significant discount.
Still, investors will accept the risk if they feel they're being paid for it. John Brignola, managing partner of LBC Credit Partners, said many of the second-lien deals have not been priced adequately, causing them to do badly in the secondary market. "The market was overheated a year ago," said Brignola. "There was a lot of new issuance volume in the second-lien market. People are realizing that maybe spreads need to be wider given the perceived recovery values for some of these loans."
