Leveraged Loan Prices Drop to April Lows on Default Concerns

By Pierre Paulden

July 2 (Bloomberg) -- Prices of high-risk, high-yield loans fell to the lowest levels since April in the past week on concern company defaults will rise as the economy slows.

The average actively traded loan fell to 89.32 cents on the dollar, compared with more than 92 cents in mid-June, according to Standard & Poor's LCD. The last time the debt was that low was April 1 when loans traded at 88.84 cents.

Defaults may more than triple in the next year, according to Moody's Investors Service, as record oil prices and the worst housing slump since the Great Depression drag down the economy. Loans ended a three-month rally sparked by banks reducing their backlog of debt to $70 billion from $156 billion at the beginning of the year, according to CreditSights Inc.

``Concern has shifted somewhat from the backlog to the economy,'' Jonathan Insull, a managing director at TCW Asset Management Co., which manages $4 billion in bank loans, said in a telephone interview. ``The backlog remains significant, but one can see the path to the end of that horror.''

Prices of loans made to fund leveraged buyouts were the hardest hit in the past six months. Debt that financed the $7.4 billion takeover of Chrysler LLC has fallen to as low as 50 cents on the dollar.

Defaults may reach 6.3 percent, after falling to a 26-year low of 0.9 percent in December, Moody's estimates. High-yield, or leveraged, loans are rated less than Baa3 by Moody's and below BBB- by S&P.

Investors are demanding more in interest relative to benchmark debt to buy the loans. The average new loan yielded 529 basis points more than the London interbank offered rate this year, compared with 238 basis points a year ago, S&P LCD said.

New Offerings Fall

New leveraged loans fell to $151 billion in the first half of 2008 from $604 billion a year earlier, according to data compiled by Bloomberg. Deals included financing for San Francisco-based Hellman & Friedman LLC's $2.9 billion February acquisition of Goodman Global Inc., a maker of air conditioners, and $1.36 billion of loans that back Carlyle Group's $2.54 billion acquisition of Booz Allen Hamilton Inc.'s U.S. government-consulting business.

Crude oil rose to a record of more than $143 a barrel yesterday, completing the biggest quarterly increase in nine years. Home prices in 20 U.S. metropolitan areas fell 15.3 percent in April, the most on record, according to the S&P/Case- Shiller home-price index.

CLOs Cut Purchases

Loan prices dropped as the main buyers of loans, collateralized loan obligations, cut back, according to CreditSights, an independent bond research firm in New York.

CLOs, a type of collateralized debt obligation that repackages loans into new securities with varying risks, account for about 25 percent of loan purchases this year, down from 63 percent in the first half of 2007, according to CreditSights.

Loans for Chrysler traded as low as 50 cents on the dollar on concern the automaker may run out of money, compared with 63 cents in April when Goldman Sachs Group Inc. sold $500 million of the debt to investors. Auburn Hills, Michigan-based Chrysler has enough cash and has no plans to file for bankruptcy protection, spokesman Dave Elshoff said in a June 26 interview.

Banks may struggle to reduce their holdings, said Scott D'Orsi, a partner at Boston-based Feingold O'Keeffe Capital, which has $1.3 billion in assets.

Lenders are still set to fund the C$52 billion ($51 billion) takeover of BCE Inc., Canada's largest phone company.

Citigroup Inc. and Deutsche Bank AG are leading banks offering loans to finance the $17.9 billion buyout of Clear Channel Communications Inc. They initially offered $3 billion of the loans at 90 cents to 91 cents on the dollar and have cut the price to 85 cents, according to David Novosel, an analyst at Gimme Credit Publications Inc., a bond research firm in Chicago.

``It's premature to say the backlog is over,'' D'Orsi said. ``After success in April and May banks are finding it more challenging to sell off the pipeline, and the hangover supply will begin to compete with the new, better structured deals.''

To contact the reporter on this story: Pierre Paulden in New York at ppaulden@bloomberg.net
Last Updated: July 2, 2008 00:01 EDT