January 10, 2020 / 11:38 AM / 16 days ago

European secondary loans experience low volatility in 2019

LONDON, Jan 10 (LPC) - Europe’s secondary loan market experienced low volatility in 2019 as deep liquidity and a desire to put money to work saw investors brush off market uncertainties such as Brexit and trade war.

Average bids on Europe’s top 40 leveraged loans started out the year at 97.35% of face value on January 2 2019, following a turbulent fourth quarter in 2018. Prices rebounded quickly from the January low and peaked in May at 99.16, before finishing out the year at 98.49 on December 31, according to LPC data.

“There wasn’t much volatility across the board. It was a benign credit environment, all the shocks that happened in the market didn’t seem to affect leveraged loans,” a loan trader said.

There were some blips throughout the year, especially as investors responded to an influx of deals in November and cleared the decks in secondary to make room for new primary issue. The top 40 composite dropped to an average of 97.9 in November as investors piled into deals, including Merlin Entertainments’ £2.193bn-equivalent buyout loan, prior to year end.

“Investors needed to sell off to make room for new loans in their portfolio,” the loan trader said.

DIFFICULT NAMES

Overall, only four names in Europe’s top 40 composite tumbled below 90% of face value towards the end of 2019, according to LPC data. They were Dutch-headquartered business services firm TMF Group, French funeral operator OGF, German packaging firm Kloeckner Pentaplast and printing and packaging supplier Flint Group.

Some of them are credit specific reasons such as Flint, which is highly leveraged with Moody’s adjusted leverage ratio at more than 9.0 times, following weaker than expected 2019 first quarter result, while OGF’s decline in secondary is more of a sector issue.

The euro tranche of the Ontario Teachers’ Pension Plan-backed OGF hit as low as 80.69% of face value in mid-November, while another funeral operator Memora — which is also owned by the Canadian pension fund — dropped to 84.5% of face value as of January 6, 2020, LPC data showed.

“The sector is under some pressure. It’s a fairly predictable business in some parameters but it’s quite a competitive industry,” an investor said. “Also, a low mortality rate and moving away from traditional burials to cremations has had an impact on OGF and Memora.”

Funeral operators normally make more income on burials than cremations.

AIR POCKETS

Looking forward, the drop in some leveraged loans could come quick and sharp as investors remain cautious around more risk-perceived credits and cyclical businesses, amid a late stage credit cycle.

CVC-backed TMF’s €200m second-lien loan fell significantly in just a few days to 60% of face value on December 10 from 83% on December 5, while its €950m term loan B was trading at 83% of face value on December 10, having fallen gradually from 90% on November 1, according to LPC.

The company has been on the watch list of debt restructuring advisers for some time but is in no immediate danger of a liquidity crisis, a source said.

Some investors believe a sharp drop in some troubled credits reflects the issue of leveraged loans’ covenant-lite structure and loose documentation, which increases a borrower’s ability to increase debt. Both of these factors could trigger nervous investors to sell off fast if they lose their confidence.

“There are no covenants, there are no triggers for sponsor to get everyone to sit together. You won’t have discussions about increasing margins or sponsors putting more money in,” said a CLO manager.

As such, secondary loan trading may adopt the same volatility featured in the high yield secondary market, when the trickiest credits go into free fall when things turn sour.

“Going forward difficult names may hit a huge air pocket,” the CLO manager said. (Editing by Claire Ruckin and Chris Mangham)

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