Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Say you and a friend buy some apples. You have an understanding that you’re going to hold onto them until you can sell them for 90 cents each. But then your friend decides that they’re worth 85 cents apiece now, advertises the price and chooses to sell. You’re more or less forced to sell at the same price, and you’re naturally annoyed.

That, in a simplified nutshell, describes a squabble between Goldman Sachs and other Wall Street lenders who helped finance last year’s biggest leveraged buyout, Carlyle Group’s takeover of Veritas, the data-storage unit of Symantec.

Goldman upset the apple cart, for sure. But it also raised a critical question about how those apples are valued, and how the same ones can have two prices at the same time.

Big Bets
Veritas was last year's biggest leveraged buyout, with an announced value of $6.6 billion
Source: Bloomberg

Goldman was left holding about $120 million of the $3 billion in risky debt that financed the Veritas deal. The bank, which has a long-standing practice of assigning daily market prices to its holdings, found it attractive to sell its slice of the debt at 85 cents on the dollar, which was 5 cents lower than what other banks wanted but at least higher than it had been.

Goldman's move was a problem for other banks, especially because they reportedly had some interest in the debt at the higher price, according to Bloomberg News reporters Sridhar Natarajan and Dakin Campbell

Going It Alone
Shares of Goldman Sachs are down about 18 percent this year
Source: Bloomberg

"By going it alone at a lower price, Goldman Sachs forced the other banks in the lending syndicate to cut their asking prices and forfeit money they’d been hoping to recover on a loan they’d all been holding on their books since credit markets seized up late last year," the reporters wrote.

Rocky Road
Prices on speculative-grade loans have recovered a bit after a drop earlier in the year
Source: S&P/LSTA US Leveraged Loan 100 Index Price

Goldman did two things wrong, or so the implication goes. It evidently broke some informal rule in the syndicated-loan market about lenders all selling the same debt on some agreed-upon price. And it challenges the models that other Wall Street banks are using to evaluate their holdings.

Let’s address the first point. It’s understandable that a group of banks would want to have some basic understanding of what something’s worth because they helped create it and were selling it at the same time. But is it acceptable to just have a gentleman's agreement among bankers that everything will sell at the same price, regardless of the circumstances? Not really.

To resume the apple metaphor, if a fruit vendor wants to make room for a new shipment of apples, it would make sense for it to put its existing ones on sale, even if it loses money in the process. And it would seem wrong if all the other fruit stands in the area told the apple vendor it couldn't adjust its prices based on its specific circumstance simply because the move could lower all their prices. That's not how markets should work. In fact, there are laws against that type of behavior.

As to the second point, it makes sense for banks to price their holdings according to current market values. If the other banks thought the debt was worth 90 cents, they could've held it longer and waited for a further rally and accepted the pain of marking the securities at 85 cents. And if they weren't marking them in real time, that means for accounting purposes they were willing to hold them to maturity, so they should have backed up that stated willingness by actually keeping it on their books.

In bucking convention, Goldman irked its syndicate partners. But it also exposed the disparity between their internal pricing practices. Goldman shouldn't be the outlier on this one.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net