Salient to Investors:

  • The $1 trilli0n unregulated market for leveraged corporate loans – from $35 billion in 1997 – poses a growing threat of gridlock in a downturn when investors expect to get their money back.
  • Beth MacLean at Pimco said one single retail fund unable to meet redemptions would have a ripple effect on the whole market, while some of the worst delays in settlement can be found in the market for new loans, where it can takes months to complete a purchase.
  • The LSTA said the time it takes to settle a loan is now an average of 20 days versus 17.8 days in 2007 and 3 or less days in the high-yield bond market. Mutual funds bought 32% of new loans in 2013 versus 15% in 2012.
  • Company loans are no longer mainly private transactions between one bank and one borrower but mostly syndicated to investors who can then trade them.
  • Lipper said that in 2013 a record $62.9 billion flowed into mutual funds that buy the mostly speculative-grade debt.
  • Erik Gordon at the University of Michigan said pension and retirement funds have poured in for the yield, and are investing people’s retirement funds in riskier investments. Gordon is concerned about a liquidity mismatch – when investors try to redeem and cannot get their money back right away, more will try to pull cash, risking a run.
  • Delays would not happen in a bond offering, but is permissible in the loan market.
  • Scott Page at Eaton Vance said one reason Wall Street banks are not streamlining trading is that they benefit from the status quo – earning fees for committing to fund deals until they close while shifting risk to investors. Big banks typically earn fees of 1% to 5% for arranging a leveraged loan versus 0.5% on bonds for investment-grade companies, and 1.3%for junk notes. Page said having an archaic system break would ultimately be more expensive for everyone, including the agent banks, but many have approached them and they have no interest in fixing the problem.
  • Buyers and sellers can trade stocks and bonds among themselves, but need the approval of corporate borrowers before they can exchange loans. Clerks must then update loan documents to reflect new lenders. Virginie O’Shea at Aite Group said a high amount of faxing is still going on even in this day and age.
  • Dennis MacKee at Florida State Board of Administration said bank loans are a source of stable returns, less risk to rising interest rates; with the trade-off of some liquidity.
  • Arthur Levitt said the longer the wait, the greater the danger for investors.
  • Elisabeth de Fontenay at Duke Law School said bank fees would decline or disappear if the debt fell under securities rules.
  • Stephen Tu  et al at Moody’s warned that should investor inflows reverse, the mismatch in bank-loan funds could pose a material risk.

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