The time it takes to settle a trade involving junk-rated loans has risen to more than three weeks even amid efforts to modernize a booming market that still relies on faxes to conduct business.
Clearing a leveraged-loan trade in the first quarter took 23.4 days on average, the lengthiest lag in at least seven years, according to a study by the Loan Syndications and Trading Association. The New York-based trade group recommends that deals close within seven days after the transaction takes place.
Delayed settlement may make it harder for buyers to get their money out in a timely manner from a market that’s grown to $700 billion when demand dries up. More cash than ever has flowed into the loans that are used to back leveraged buyouts as investors seek protection in the floating-rate debt from rising borrowing costs as the Federal Reserve prepares to withdraw its record stimulus.
“Settlement needs to be addressed now,” Jason Rosiak, head of portfolio management at Newport Beach, California-based Pacific Asset Management, the Pacific Life Insurance Co. affiliate that oversees about $4.4 billion in assets. “Because of the velocity at which settlements are being dragged out, it could become an issue down the line. But we’re not there yet.”
The average settlement time of a par, or performing, loan in 2007 was 17.8 days, according to the LSTA study. That rose to 22.9 days in 2013.
Loan participants have communicated using facsimile machines for portions of the market, with more than four million faxes received by loan custodians in 2012. In recent years, companies have been seeking to automate portions of the loan market and replace the millions of faxes exchanged with electronic messaging.
Issuance of new leveraged loans reached a record $355 billion in the U.S. last year, and $113.9 billion has been arranged in 2014, according to data compiled by Bloomberg. The surge is being driven by loan mutual funds and collateralized loan obligations.
Investors poured a record $61.3 billion into leveraged-loan mutual funds in 2013, according to Morningstar Inc. Last year, $82 billion of CLOs were raised in the U.S., according to Royal Bank of Scotland Group Plc data.
The active new-issue loan market led to a 31 percent increase in trading volume in 2013, with $517 billion last year, according to the LSTA study. There was $396 billion of volume in 2012.
CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return. Leveraged loans are rated below BBB- by Standard & Poor’s and less than Baa3 at Moody’s Investors Service.
Delayed settlement might mean that mutual funds hit with large redemptions won’t be able to get the money from the sale of the loan in a reasonable time, Rosiak said. Additionally, loan prices can fluctuate in the weeks before a trade is completed.
Some mutual funds, especially those for bank loans, have an outside liquidity facility that is meant to bridge the gap for a portfolio if there is a significant amount of withdrawals and a firm can’t sell and settle trades fast enough to get the cash back it needs to meet those redemptions, Rosiak said.
Firms must pay for the outside facility, sometimes structured like a line of credit. The cost can include up-front fees, as well as a percentage based on the usage of the loan, he said.
The rise in settlement times was reported earlier today by the Financial Times.
“Bank loans have become a mainstream asset class” and “this has taken a great deal of education and time,” Rosiak said. “It would be a shame, if because of an operational issue of settlement, people second guess” loans “as part of their asset allocation.”