Debts & Loans

Loan market war of words erupts over settlement delays; dirty little secret behind fund losses

Deteriorating loan prices and extensive trade settlement delays have set off a market firefight as both sides of the Street trade accusations and invective. The gridlock has infuriated buyers of loans who bid on debt in recent months only to watch the market value of their investments tumble precipitously before their trades even settled.

Hold-ups are most prevalent in the distressed loan market, where the volume of trades doubled in 2Q to approximately 3,500, according to data provided by the Loan Syndications and Trading Association (LSTA). In 2Q, the mean settlement was T+40 versus the T+30 median and 33% of trades occurred within T+19 against a target of T+7.

Settlement times have ballooned since then, but even the 2Q average and median far exceed what most trading desks deem acceptable. “[For] distressed stuff, we are at about T+20,” said one buyside trader”. “If not, there better be a darn good reason.”

And there’s the rub. There are as many reasons for the broad slowdown in execution as there are participants in the market.

Hedge fund managers blame their dealers for delaying settlement to boost returns on naked shorts. Dealers say the hold up is coming from loan agents who prioritize trades executed by their own desks and agent banks point their fingers back at the buyside and the unprecedented flow of transactions triggered by fund redemptions and liquidations.

Blame game aside, the pain inflicted by slower execution is serious. Investors who put in tickets to buy TXU’s benchmark USD 16bn loan in late September, for example, watched the debt tumble over 20% to 70 by mid October. The list of walking wounded hit by loan-related losses grows by the day, including market titans such as Highland Capital, Sankaty Advisors, and Blue Mountain Capital, according to published reports.

Some investors claim that dealers fuel those losses by selling loans they do not own and then willfully delaying trade settlement until they can short cover. Short selling is an acceptable part of a dealer’s ability to create a two-sided trading market but the line between manipulation and business-as-usual is a blurry one, said several portfolio managers, traders and lawyers.

Forcing dealers to toe that line is especially difficult in the loan market. Sellside trading desks can push settlement out with impunity because investors lack any mechanism with teeth to punish foot-dragging dealers, said one portfolio manager.

Current trading documentation allows would-be loan buyers to serve sellers with a buy-in notice, but only within a window spanning T+7 to T+13, said an LSTA source. The notice stipulates that the seller has failed delivery and if necessary must cover the cost of purchasing the loan elsewhere, potentially at a higher cost.

But given that trades aren’t considered past-due until T+14 under historic norms, investors face strong pressure not to pull the trigger. “The buyside has the option of submitting a buy-in notice but we were told by one dealer … that if we did that, they would never do business with us again,” said the first PM.

The LSTA claims that new documentation will be published by year end to establish a buy-in and sell out procedure to make a “definitive impact on manipulative short selling,” said the source within the organization. The new docs would allow a buyer to serve a buy-in notice any time after a counterparty fails to deliver within T+30, the source added.

The protocol change may discourage some short selling but it won’t address the logistical underpinnings of the settlement logjam, said a second senior PM.

In a typical loan transaction, a buyer calls a sellside dealer with a request for paper, the dealer writes a trade ticket and sends a written confirmation for the buyer to fill out and return. The trade is then booked but the dealer must wait for the borrower to approve purchase and sign a sale agreement. Lastly the confirmations are sent to the loan agent who needs to process the trade.

The final stage can be the most problematic because agent banks prioritize trades executed by their own desks ahead of those submitted by competitors, said two sources on Wall Street trading desks. Trades for loans issued by Tribune, for example, lingered with JP Morgan, the agent bank, longer than they should have, said one of the trading sources.

Tribune’s USD 7.57bn term loan B has cratered recently to 44/688-46.438 after being quoted as high as 68.775-69.625 in early September, according to Markit. Its term loan X, with USD 593m outstanding due next spring, had fallen to 78.25-82.375 from 95.8-96.75 over the same timeframe.

Officials at JPMorgan did not return calls for comment.

Not everyone attributed agent backlog on favoritism. “Settlement is a huge issue but I don’t think it’s necessarily malicious,” said the buyside trader. “You have agent banks that have enormous internal problems and they are understaffed and guys are overwhelmed.”