Leveraged Loan Market Going Digital to Replace 4 Million Faxes

The $500 billion market for leveraged loans, one of the last to depend on facsimile machines, is turning to computers to save time and money as stock, bond and commodities exchanges have done for years.

More than four million faxes with information ranging from quarter-end payments to interest rates were received by loan custodians in 2012. JPMorgan Chase & Co. and Citigroup Inc. are now sending private electronic messages to eliminate some of that paper, according to data provider Markit Group Ltd.

While lending has grown 130 percent since 2008, loan trades still take as long as three weeks to settle, compared with three days for stocks and bonds. Modernizing the largely unregulated market, which has financed companies such as MGM Resorts International and Six Flags Entertainment Corp., would cut costs, reduce manual errors and add transparency.

“I thought the fax lobby was behind the continued use of all those faxes,” Andy Viens, senior vice president, operations at Sankaty Advisors LLC in Boston, said in a telephone interview. The new system “can eliminate some of the re-keying and the cost could go down as part of that automation.”

Bank of New York Mellon Corp.’s trustee group handled 650,000 faxes, and processed 376,000 transactions and 26,000 loan trades during the third quarter, Jocelyn Lynch, managing director at BNY Mellon Corporate Trust in Pittsburgh, said in an interview. Wells Fargo & Co. received 348,575 documents in August, September and October, according to the San Francisco-based bank.

Replacing Faxes

JPMorgan, the second largest arranger of U.S. leveraged loans in 2012, and Citigroup, the sixth biggest, started getting rid of all those faxes last year by sending electronic notices to a unit of London-based Markit. The banks are using Financial Products Markup Language, or FpML, to standardize messaging, Lynch said.

Notices of interest payments, trade information and loan holdings may go electronic by the end of the second quarter, Ellen Hefferan, vice president of operations at the Loan Syndications and Trading Association, or LSTA, said in an interview.

Automated clearing might reduce costly settlement delays. An investor who bought into the Cengage Learning Inc. $1.3 billion term loan at 91.125 cents on the dollar Nov. 2 would have had a paper loss of 21 percent while waiting three weeks for the purchase to close, as the price tumbled to 71.75 cents after the textbook publisher reported that quarterly net income dropped 90 percent from a year earlier.

Market Delays

Leveraged loans are rated below BBB- by Standard & Poor’s and less than Baa3 at Moody’s Investors Service.

Loans don’t trade publicly and aren’t regulated by a specific government agency.

“Not having automated clearing is one of the things that drags down the loan market,” said Jason Rosiak, head of portfolio management at Newport Beach, California-based Pacific Asset Management, the Pacific Life Insurance Co. affiliate that oversees about $3 billion in assets. “With a bond you deliver and get payment. Loans settle physically, which is different.”

While trades of performing debt settle in about 20 days, distressed loans might take as long as 53 days, according to the LSTA. Under guidelines from the New York-based trade group, those would shrink to seven and 20 days.

Issuance Boom

The move to develop FpML for leveraged loans didn’t begin until 2007 when issuance ballooned to $891.9 billion, a 48.8 percent increase from 2006, according to data compiled by Bloomberg. Trade volume more than doubled between the first three months of 2005 until the third quarter of 2007, when $125 billion of the debt changed hands in the U.S., according to the LSTA.

The market value of institutional loans outstanding was about $500 billion in July 2012, according to the trade group.

“The old way of settlement could not keep up,” Bram Smith, executive director of the LSTA, said in an interview last month.

While the development process started six years ago, notices sent to Markit’s loan-messaging hub didn’t go live until last year.

“Loans are idiosyncratic,” Smith said. “They are much less standardized than bond indentures because their terms are more customized to each borrower’s needs than bonds typically are.”

Borrowers sometimes must approve any new investors before a trade can be completed. In the past there was no time limit for the borrower to sign off on deals, causing some transactions to stall.

Deemed Consent

To speed the process the LSTA introduced so-called deemed consent language. A borrower must object typically within five days to stop a trade. By the fourth quarter of 2011, about 84.6 percent of credit agreements contained this clause, according to a report from Xtract Research and the LSTA.

Some traders seek to push out settlement dates because they either don’t have a loan ready to sell or they want to hold onto cash longer, BNY’s Lynch said.

Carl Icahn’s High River LP was ordered by a judge in December 2011 to pay more than $25 million to Goldman Sachs Group Inc. after the investor failed to complete nine sales of Delphi Corp.’s bank debt “as soon as practicable,” as dictated under LSTA trade papers, according to a Dec. 22, 2011 ruling. High River didn’t deliver the loans to the buyer at all.

“Loan trading is an arcane thing,” Keith Schaitkin, general counsel at Icahn Enterprises LP, said in a telephone interview. “It would be great to bring it forward,” he said about advancing loan trading and settlement. He declined to comment on the court case.

Michael DuVally, a Goldman Sachs spokesman, declined to comment on the case.

Faster Settlement

Markit is seeking to provide processing technology for loan trades that could lead to settlement in one to three days, Scott Kostyra, managing director and global head of loan settlements at the company, said in a November telephone interview.

A non-contested trade would be able to flow through the company’s Markit Clear unit with no manual intervention and go straight to settlement, he said. Exceptions might include an investor needing borrower consent. The program uses trade matching to confirm terms each party enters into the system.

“Once this goes live and everyone is on board, I think it will be great for our market,” Katherine Stewart, head of loan closing at Wells Fargo in Charlotte, North Carolina said. “It will reduce settlement times significantly.”

First Deals

JPMorgan, Bank of America Corp. and Citigroup have deals on the system, Kostyra said. Loan trades will continue to be completed on the phone between two traders, he said.

Markit Clear will help automate settlement, not trading, and is planning to introduce custodian services. The offering will allow all documents associated with a trade to be delivered securely to both the buyer and their designated custodians, Kostyra said.

“The biggest advantage is it provides some transparency in the process to see where someone is short a position or is waiting on their trade to settle,” said Sankaty’s Viens, referring to Markit Clear. “It will give more clarity to the process than what is there today and it helps, hopefully, lead to faster settlement times.”

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