Leveraged-Loan Market Provides More Hope

The leveraged-loan market is small, with only $600 billion of loans outstanding. But it is a very important part of the overall credit story. A lot of the writedowns from investment banks came from losses on leveraged loans stuck on their books. This market has historically traded around par value, and its investors (lenders) were made up of large international banks.

While still small, this market has grown threefold since 2005 because there was increased demand for high-yielding loans in the form of CLOs (collateralized loan obligations). With this demand now gone and banks' balance sheets under increased duress, there have not enough buyers to handle the supply. Basically, the amount of loans outstanding has exceeded the amount of investable dollars dedicated to this market.

The leveraged loan market currently trades at 71 cents on the dollar with yields reaching 12%-15%. Don't forget, these securities are the most senior part of a company's capital structure. Regardless of the market's small size, it is still an important indicator of the health of companies.

In the last few weeks, there have been several Bid Wanted in Comp (BWIC) lists, mostly from European banks which were big lenders in this market. These lists of loan securities are presented to broker-dealers, who then go out and try to find investors to bid on the securities (typically hedge funds that specialize in distressed debt, and are taking advantage of a "once in a lifetime" event in the loan market). In the last three weeks, there has been roughly $4 billion worth of loans on these bid lists looking for a home. Some of this supply cleared, some did not.

But this week there has been huge demand for these lists, and many of them were two times oversubscribed. I've even heard that several funds have bid on the entire list, hoping to buy the entire package of loans at a depressed price by virtue of buying them all.

This newfound demand is coming from equity buyers and corporations that are buying back their own loans. I've heard from several sources that big broker-dealers are teaching their equity sales forces about the loan market, who are then teaching their equity clients about this opportunity. This is the new investor base the credit markets have needed, and reinforces the theme that money will be pulled out of equities and reallocated into fixed-income products. This investor base is pulling money out of equities and buying these cheap loans. This is a very encouraging sign for the overall stability of the financial markets, as this mess of cheap debt has to be cleaned up before equities can truly recover.

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At the time of publication, Dorman had no positions in the stocks mentioned.

Dorman has traded in the U.S. corporate bond market for more than severn years; for the last three years, he's worked as a high-yield and distressed corporate bond trader for Merrill Lynch. Prior to Merrill Lynch, Dorman worked as a credit analyst/trader on a distressed prop desk for Friedman Billings Ramsey and as an investment banker and capital markets analyst for Lehman Brothers.

Dorman graduated from Washington University in St. Louis in 2001 with a bachelor's degree in economics and finance and a minor in biology. Dorman played varsity baseball and football for Washington University.