The incredibly shrinking spreads on new issue loans that have haunted investors like a B-grade movie for the better part of the last year are finally fattening up, thanks to horror stories playing out in other markets. Jitters in the equity markets over accounting scandals, a slackening of demand from retail funds and institutional buyers and three straight weeks of bond outflows have caused secondary pricing in the loan market to soften. Spreads over LIBOR are starting to follow suit and are getting bigger. "You've seen in the last 10 days the market has changed," said Art Zimmer, senior v.p. and portfolio manager at OppenheimerFunds. "Refinancings at lower spreads and new deals getting flexed down are not going to continue. People are putting their foot down." Zimmer cited a slackening demand from retail funds and institutional buyers as the reason behind the sea change.
The juicier spreads are a welcome change for investors. "Leveraged loan spreads have been declining since December 2001 and continued to fall last month," commented J.P. Morgan analyst Christopher Flanagan. "The combined effects of Adelphia and WorldCom's downgrade and general market uncertainty should make it difficult to continue the aggressive pricing seen recently and will likely put upward pressure on spreads," he added. Last month saw spreads on double-B loans tighten 15 basis points to LIBOR plus 246, marking the lowest levels since August of 1998, according to Standard & Poor's PMD data.
There already are signs that the market is turning. Salomon Smith Barney credits for Giant Eagle and Moore Corp. were flexed upwards 25 basis points last week as investors cited a lack of familiarity with the issuers (see story, page 2). J.P. Morgan's attempt to cut pricing on SPX, meanwhile, is said by some investors and bankers to have run into trouble. Officials at the banks and companies did not return calls.
Declining levels in the secondary market also make the new issuance less attractive. One buysider asked, "Where are the 101 bids?" Recent new issues for Calpine, Terex, Seagate Technologies, Express Scripts, Fleming Companies and Silgan Holdings have gone from 101 bids to just over par or below. "It's insane that these credits would be trading at 101," noted one trader. "It's finally starting to catch up with people."