Investment banks: The loan market’s tipping point

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Banks are paying the price for hanging on to their stuck leveraged loans for so long.

Investment banks are showing as strong a herd mentality when it comes to getting out of their LBO investments as they did getting in to them. Recent weeks have witnessed a sudden rush of leveraged loan sales from institutions that have been grimly sitting on their $250 billion loan stockpile as prices in the secondary market have headed steadily south.

According to Bloomberg, secondary loan prices had recovered to 92 in late April, having hit a record low of 86.3 in February, so many banks have now grasped the opportunity to sell. But there are many loans that will struggle to price above 90 – news that Goldman Sachs and Citi are now selling their Chrysler exposure at less than 65 is a stark indication of where some of the bumper LBOs are now trading. And with everyone seemingly stampeding for the exit at the same time, all those opportunity funds that have been waiting in the wings for months are starting to look very smart indeed.

The banks are clearly under so much pressure to free up lending capacity that they probably have little choice but to sell. One thing that the firms putting portfolios on the block have in common is that they were all very active at lending on aggressive terms to the bumper LBOs that took place in recent years.

Deals such as Chrysler and First Data in the US were so big that it can be reasonably assumed that every large bank involved in leveraged finance probably has some exposure on their books. And if every bank is forced to shift it, they have little choice but to take whatever price they can get.

The extent to which the buyers have the upper hand now that these overhangs are finally moving is revealed by the news that investors are being allowed to cherry-pick loans from the portfolios on offer. Despite the obvious pressures on banks to free up lending capacity, it seems baffling that they are prepared to let buyers pick off the good credits at sub-par prices and be left with the dross: most probably over-levered deals from 2006 and early 2007.

There is a sense that everyone is grasping at the first sign of a recovery in loan prices to get shot of as much of their backlog as possible. Indeed, in late April the eight banks that underwrote the KKR buyout of Alliance Boots just before the crisis announced that they were to revive syndication of that deal in an attempt to shift the £9 billion ($18 billion) of loans they got stuck with as the market shuttered last July.

If the herd of firms now frantically offering up their loans for sale becomes much more of a stampede, the price recovery in the secondary market could end up being very short-lived indeed.