Japanese and European banks put billions of dollars worth of loans up for sale at the end of the second quarter, in a bid to boost returns and gird themselves for a possible merger wave, bankers said.
The massive selloff of investment-grade loans-expected to last through the end of the year-has pounded the secondary market in the last eight weeks, driving down prices by as much as 4%, traders said.
If the selloff continues in the second half-and many traders think it will-prices would probably decline further. The glut will also probably drive up the cost of new investment-grade loans for corporate borrowers, because investors will have more to choose from, bankers say.
"The secondary market is directly tied to the primary," said Jeff Glasse, managing director for Toronto-Dominion Bank and Trust. "These days investors are more willing to go to the secondary if prices are cheaper."
They have been. On one trading day more than $11 billion was on the market from foreign banks. In one high-profile trade, a Japanese bank sold $10 million of investment-grade Time Warner Inc. paper at a 0.875% discount from its face value. Still, that figure was below the 1% to 2% average discount reported marketwide.
Jonathan Kitei, managing director of loan trading for BancAmerica Robertson Stephens, said offers to sell huge blocks began to circulate in the first quarter, mostly by Japanese banks. By the second quarter European banks, led by the France's Societe Generale, began to flood and eventually depress the market.
"It wasn't a singular offer that got my attention," Mr. Kitei said. "It was the lists of 30 to 50 names" that began to circulate, "and those lists are still out there."
Analysts say that for the Japanese, the selloff suggests the banks are serious about managing returns to bring them in line with western banks. The European banks may be trying to boost share prices in anticipation of a merger wave that is expected when the euro comes on line.
"The Europeans are going through a consolidation craze," said the head of syndicated lending for a major French bank that has been heavily selling paper. "They're considered to be two years behind the U.S. trends. But they're trying to get a higher return on equity and drive up their own stock price."
A higher stock price means a big return for a bank if it merges or is bought. Japanese and European banks have historically low returns, around 8% to 15%, compared to U.S. banks, many of which return close to 20%.
But there are other factors forcing the selloff, traders said.
The European banks also "have a lot of exposure to Asia," a secondary market trader in New York said. "They're learning to deploy their capital efficiently."
And the Japanese are taking on mounting losses on their investments in high-quality loans. Except for Sumitomo and Bank of Tokyo-Mitsubishi, Japanese banks are facing extremely high costs for their own debt service and faltering loans. An investment-grade loan returns only the London interbank offered rate plus less than 1 percentage point, offering no stopgap to mounting losses.
Loans, even those sold at a discount, generate money that can be reinvested into bonds or high-yield or riskier securities, the kind that U.S. institutional investors have been gobbling up for years.
However, to unload the paper, banks must be willing to slash prices. U.S. banks have been backing away from such low-yielding paper, and institutional investors buy only leveraged loan paper.
So who's buying? Traders say it has been regional banks less beholden to traditional banking custom. Such banks can buy a $1 million block of a high-quality loan for as little as $960,000.
"Many of the big banks are old and stodgy" one trader said.
"It makes perfect sense to buy this stuff at a discount, but the big banks have been sloppy."