Perhaps nowhere has rapid-fire selling been more pronounced than in the $500 billion market for so-called leveraged loans. In recent years companies sold these securities to finance private equity buyouts, acquisitions, and other corporate deals. But hedge funds, which lined up to buy the loans during the boom, have been off-loading them in recent weeks to meet redemptions and margin calls.
Highland Capital Management, a $38 billion money-management shop that invested heavily in this arena, has been among the most aggressive sellers of leveraged loans. Highland declined to comment.
The sell-off by hedge funds and other investors is depressing loan prices. In recent weeks the value of the typical loan, according to research firm Standard & Poor's LCD, quickly dropped from 85¢ on the dollar to just 66¢, a deeply distressed price usually reserved for companies that are in bankruptcy. (Historically, investors have recovered 70¢ on the dollar when a company defaults.)
Yet few of the companies whose loans are trading near those prices, including utility TXU Energy and credit-card processor First Data, are in such dire straits. "The loan market is a very funny place right now," says David Ford, a founding member of Latigo Partners, a hedge fund that buys distressed investments. "It's not being driven by fundamental forces."
In essence, the market is suggesting that owners of such securities won't get their money back. That unlikely scenario has some market observers scratching their heads. In the event of bankruptcy, investors in leveraged loans are the first to be repaid, outranking other holders of corporate debt and stock. And many companies today have more than enough assets on hand to make their loan investors whole. For example, Tennessee-based Community Health Systems (CYH), whose loans are selling for roughly 75¢ on the dollar, has $9 billion in assets, far more than its $6 billion in loans.
~ BusinessWeek, "The Hedge Fund Contagion," October 22, 2008 (Nov 3. issue)