LONDON Feb 28 Europe's secondary loan market
has peaked at an all-time high with the composite reaching
100.94 this month, according to Thomson Reuters LPC data,
fuelled by a supply-demand imbalance that is affecting banks as
traders take hits to cover costly shorts.
Europe's leveraged loan market has been flooded with
liquidity from a series of new CLOs, warehouses, managed
accounts and a bout of repayments. But with very little new
primary supply, investors have been forced to buy paper on the
secondary loan market, pushing prices higher.
"Secondary prices have risen to extremely high levels due to
supply and demand - it is no more scientific than that. There is
not enough new paper in the market to satisfy the amount of cash
knocking around," an investor said.
At 100.94 on February 2, Europe's top 40 leveraged loans hit
a high not even seen before the financial crisis. The closest
the composite had previously reached was 100.72 on April 20
2007, according to TRLPC data.
The unprecedented bid levels are catching out a number of
traders, who agreed to sell paper to investors at a certain
price but are finding they can only source the loans at higher
levels, contradicting expectations they could find the paper at
lower levels and book a profit on the difference.
"Everyone is desperate for paper and trying to provide
liquidity to the market is very difficult. If you are able to
and you do short, when the market goes like this, you can get
into a right pickle," a loan trader said.
Shorting individual credits in the loan market is a
long-established practice, given the long settlement process.
While some shorts have gone wrong previously, it is now becoming
widespread as traders book losses against the wholesale increase
in loan pricing.
With many sales agreed in December and January, traders are
now attempting to cover a series of shorts, which is also
pushing prices higher as potential sellers take advantage of
traders scrambling to honour trades.
"There is a natural ability to short loans because of the
clunky nature of settlements. No one realised the market would
go as high as it has and the desperate plight of traders to find
the paper they have shorted is now pushing prices up even
further," a second loan trader said.
In some instances, traders are unable to source the paper
they have shorted, which has led to the trade being pulled
"Somebody shorted something which was very foolish as they
couldn't source it, so they had to rip up the trade in the end.
The paper was smuggled away into CLOs that are so desperate for
loans that they wouldn't sell, no matter the price. It is very
unusual and has never happened before to this buyer. It is a new
development and now there is the question of how to deal with
this new concept," a second investor said.
Traders are mainly booking shorts of around one to two
points, equating to a 1%-2% loss on a trade. A series of these
could see some hefty losses for banks.
"One percent of a €10m trade is €100k. That isn't going to
have much effect, but if you've done 10 of these shorts, that's
a loss of €1m on the books. That will have an impact," a third
British holiday park operator Parkdean Resorts' £575m term
loan B, which backs the company's buyout by Onex, allocated with
an OID of 99.5 on February 9. It broke at par and was quoted at
101.6 on February 28. French call centre operator Webhelp's
repriced €560m TLB2 allocated at par on January 12, and was
quoted at 101.25 on the break and 101.4 on February 28,
according to TRLPC data.
Even more tricky credits are on the rise in this market.
Israeli furniture maker Keter's €320m add-on term loan B3,
backing its acquisition of Italian peer ABM Italia, allocated
with a 97 OID on February 9 and was quoted at 97.46 on the
break, rising to 100.6 on February 28, TRLPC data shows.
A lack of supply in a liquid market and a rise in secondary
prices have led borrowers to raise additional debt for bolt-on
acquisitions and reprice existing portfolio companies on more
These deals are offered with 101 soft call for six months,
helping loans to trade higher on secondary as soon as they
break, as investors feel confident the loans are unable to
reprice and return to par, without the borrower paying a hefty
Soft call wasn't offered before the financial crisis,
helping current prices to peak to levels not seen before.
"Pre-financial crisis loans were not offered with call
protection, so on the break they only rose a little. When deals
get done today, they are offered with soft call so there is
scope for them to trade up," the first investor said.
The relentless upward trajectory of loan pricing is set to
continue unless new supply comes to the market or an unknown and
shocking geopolitical or economic event occurs.
As a private market, European secondary loans are more
insulated to wider macro events than other capital markets.
Despite taking a bit of a hit after the Brexit referendum and
Trump's election win, the market bounced back within a few days
and few hours, respectively.
(Editing by Christopher Mangham)