A wave of bad reports from companies is rocking the secondary loan market as never before, as increased liquidity and mark-to-market pricing make bank debt much more sensitive to bad news. A slower economy and bad credits are nothing new, but dealers unanimously agree the market has become more reactive to disappointing news, with players racing to unload paper as soon as a company issues a quarterly report or a rumor hits the market. "That's the difference," one trader said. "People are willing to sell on the news."
Two weeks ago engineering and construction company Washington Group announced it may violate some of the terms of its credit, signed only last June, because of unforeseen financial snags. Overnight, Washington Group's credit nosedived from par range to the low 60s, leaving many market players shaking their heads at the fumble. Last week, Nextel Communications announced that its subscription rates are down and the bank debt tumbled that day.
Rod McWalters, head trader at Commerzbank, said the snap reactions are the result of a changing loan trading market. "In 1990 if a credit had disappointing earnings, it would just sit. If it was not going to default, there was no reason to sell it," he explained. "With an evolution of the bank market, as it's become more securities-like, people are viewing loans as an asset class. The benefit is liquidity; the downside is volatility."
Another factor is the practice of marking portfolios to market. Instituted in most portfolios over the past 18 months, mark-to-market pricing has made investors more sensitive to news. "Ever since mark-to-market started people are much more worried about price deterioration," one trader noted. Dealers say the worst fear is being stuck holding onto paper. "When people react, they do it violently and quickly," a trader said.
Waiting out a rough patch, even for some of the traditionally safe credits, is becoming a risk few will take, dealers say. "Big dealers won't position themselves on some of the staple names like Charter [Communications], and that's something that all the guys keep," one trader said. "If there's a loan being done, they want it big, liquid, rated by both agencies, and they want the ability to get out."