By Randy Schwimmer, contributor
We had expected such an occurrence for days, but no proximate cause accompanied the event. As we toured the area later that afternoon, no uprooted trees were evident, no branches hammocked on overhead wires, and no telephone poles in the streets. The mystery deepened when we finally accessed the Internet and learned the regional utility had cut power “to protect the grid.” Pardon?. Of course, it took a week to restore order, leaving us to ponder the inner workings of our fragile infrastructure.
But as we headed into the Labor Day weekend, this pro forma plug pulling seemed a fitting metaphor for the similarly knee-jerk drop in loan prices in the leveraged market.
Despite no specific credit events, no newly uncovered defaults, no surprise bankruptcies, overall loan prices traded down sharply last month in the wake of sovereign debt fears in Europe and the budget stalemate here at home.
Certainly no one disputes the grim global fiscal news or its potential impact on credit instruments. Indeed, issuance in the high yield market – always the first to protect the grid at the hint of any foreboding forecast – was blacked out after mid-August. Participants there expect, or hope, new deals will be back on-line after Labor Day.
But when the S&P/LSTA Index of 100 most liquid loans dropped from 94 to 88 in ten days last month, could anyone reasonably argue that reflected a change in credit risk? Were economic conditions so dramatically altered in that brief period? Did someone just discover the back-up generator for US jobs was down? Or that Europe’s fiscal house was being powered more by futility than utility?
In contrast, middle-market loan prices held fairly steady through the heavy weather. Indeed, loan shoppers looking for small deal bargains were keenly disappointed. Despite the power outage in broadly syndicated names, there were no panicked sellers of middle market paper.
Why? Common wisdom holds that smaller loans are less volatile because their size makes them illiquid. In truth middle-market lenders are buy-and-hold investors, not traders. They evaluate companies, not off a Bloomberg, but in weeks of due diligence. They also recognize mid caps are sheltered from storms that roil public markets.
Yes, small loans don’t show up on many trading runs from large institutional desks. But that’s because their holders are less fee than volume-driven. They won’t give up a good asset for a modest trading pop after all the effort originating and underwriting it.
After Irene left and good weather arrived, we strolled along Bay Street in Watch Hill, running into a buddy who co-heads a middle market shop and owns a house in town.
“Don’t tell anyone,” he confided, “but we never lost power.”
Don’t worry. Your secret is safe with us.
Randy Schwimmer is senior managing director and head of capital markets with Churchill Financial.