Outlook 2009: Secondary average loan bid expected to rise as selling pressure eases

By Sara Rosenberg

New York, Dec. 31 - Secondary loan prices are expected to go up in 2009 from where they were in the latter part of 2008, as market players think that prices have somewhat hit a bottom and that some of the technical pressure will disappear.

"We're going to take probably most of the first quarter for the market to get comfortable with the technical picture. You want credit people to be able to make credit decisions, not supply/demand of the asset class. Hopefully there's some clarity on the technical forces that are driving the market down, so you have this established bottom, if you will," a sellside source remarked.

"You'll start to see some leveling out of secondary loan prices in the early part of the year and then some recovery in the second quarter. Hopefully, towards the end of the second quarter, it's at levels where you could start seeing some new issuance - low-to mid-80s," the sellside source said.

Secondary levels to have top, bottom

According to the sellside source, there's going to be a floor to secondary levels as well as a ceiling.

"There is just a sheer volume of debt that's out there. You're going to need to see some of that disappear. What can make it disappear? You can have someone put equity in through an IPO or through sponsor money, you can see cash flow generation used to repay at par or below par, you can see exchange offers and you can see an acquisition and then just end up repaying existing debt - sort of change-of-control repayments," the sellside source explained.

"Until you see that, there will be a ceiling on where prices can go. I think they can get to the mid-80s, high-80s. Higher than that, you're going to have to remove a whole lot of supply because the demand doesn't seem to be building.

"There's going to be other investors, equity type hedge funds, come in to the asset class and say, 'There's some compelling value here. I can get decent returns with modest leverage.' There's value there that people want to capture, but the demand side is going to really lag the supply, which is huge. We built up this huge supply and then the CLO generator just stopped. To absorb what's out there, you're going to have to take out some supply because there's not going to be enough new demand to pick it up," the sellside source added.

Market technicals expected to improve

Another sellside source agreed that the secondary market would get better in 2009, saying that a lot of the selling pressure that pushed levels down in the first place is close to reaching an end.

"Anytime we thought we hit a bottom, it's gone lower, but now that we're below 70, I just don't think it can go much lower. Loans aren't going to go to zero. I think the stuff is bouncing along at the bottom and it's going to go up next year partly because there has been more capital raised to take advantage of the buying opportunity of loans as an asset class. In that 65 to 70 range, I think we're pretty close to a bottom," the sellside source remarked.

"Driving the pricing down to 70, a lot of that was forced selling - hedge fund redemptions, unwound warehouse facilities. Most of that stuff has kind of flushed through the market already and people that don't have to sell a loan that they expect to collect at par are not going to sell it for 70 cents. I think we're bouncing along the bottom. It's going to pick up steadily," the sellside source added.

Cash to stop sitting on the sidelines

A third sellside source remarked that, although it may take until the second half of the year, trading levels should improve since there is cash to be put to work.

"Loans continue to hit all-time lows almost daily. TXU for example is trading in the mid-60s with the only major issue being high leverage. While it may take till mid-'09 for some loans to come back, there is a lot of money sitting on the sidelines that will eventually come back into the picture once banks and funds gain more clarity after year-end. While new issuance may remain dead, the secondary might see an increase in bids in '09," the sellside source explained.

Improvement seen by mid-year

Meanwhile, according to a buyside source, trading levels should improve in mid-2009 "based on how long it will take equities to completely capitulate."

"Sooner than that is more likely than later," the buyside source continued.

He added that secondary levels will rise "because loans are incredibly cheap, because the world won't go into a depression, and short average lives create impressive pressure to return to par."

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