Loan market players are forecasting a correction in the market as secondary prices continue to creep higher in the face of tightening primary spreads and as old definitions are redefined. Stressed is now near par, they said, noting that 101 is the new par. Paper that is trading below par "becomes the focus of everyone for no good reason," said one buysider. But a loan that is a decent credit is trading at 101 and then it becomes a refinancing risk, chimed another.
Although the secondary market is inching up, the quality of new loans is going down and leverage is rising. But almost every new deal is flexed down during syndication, investors said. Consequently, as spreads tighten, deals with varying degrees of risk are not priced accordingly, investors said. This trend leaves room for the secondary market to adjust for risk when the correction comes.
But when the change will occur and how is tougher to predict and many investors believe the run-up will run-on into 2004. "There's nothing on the horizon that we see that will change the tide," said one buysider. The over-priced loan environment has been driven by investors hungry for paper, the seemingly endless liquidity of the high-yield bond market and its effect on loan supply, as well as the perception that the economy is improving. But take away one of those factors and the market is likely to move, investors said. If the economy is weaker than expected, if there is a major scandal, if there is an act of terrorism or if there is a major credit event, the market will shift, they said.
But investors also noted that it is a supply and demand game. "There is still a relative lack of M&A deal flow, outside of the dividends that they are paying themselves," said one buysider. "It looks like the calendar is picking up for the first quarter, but I don't know if it's going to pick up enough," said one dealer. The current situation compares starkly with the market of a year ago when good deals were given rich spreads and the corresponding thinly priced deals were trading at 97-98, reflected one buysider.
When spreads begin to widen, investors expect secondary prices to come down. The changes may be small. Deals such as Weight Watchers International will trade at par not 101, said one dealer. Or a correction could affect loans across the spectrum. Others predict the asset-light deals and names driven up by technicals will be the first to feel the brunt of the correction. Investors speculated that at-risk names could also depend on the nature of the change. If the economy does not recover as quickly as possible, cyclical names and perhaps media companies dependent on ad revenue will be harmed, offered one buysider.