LoanX

 http://www.risk.net/risk-magazine/feature/1503652/s-p-loanx-provide-pricing-service-illiquid-leveraged-loans

S&P and LoanX to provide pricing service for illiquid leveraged loans

Published online only

Author: Gallagher Polyn

Source: Risk magazine | 06 Jun 2002

Categories: Investment, Asset Management

Rating agency Standard & Poor's and LoanX, an online pricing service for syndicated loans, plan to roll out a new service for pricing the illiquid end of the leveraged loan market by the fourth quarter. The move is important because the US Securities and Exchange Commission, which currently requires mark-to-market pricing for mutual funds invested in leveraged loans, is thought to be seeking more sophisticated standards

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Under current rules, failure by investment managers to provide defensible estimates of the market value of their illiquid loan holdings can result in criminal penalties or shareholder lawsuits. Market-oriented structured credit investors are also adding to demand for new pricing technology, market officials said.

The secondary loan trading market, which is primarily for sub-investment grade credits, is by size the poorer cousin of the credit derivatives market, which is dominated by investment grade credits.

According to the Loan Syndicators and Trading Association (LSTA), the secondary loan trading market was worth $120 billion last year. Outstanding notionals for credit derivatives were more than $1 trillion at the end of December, according to the International Swaps and Derivatives Association. Standard & Poor’s, meanwhile, said about 50-75% of leveraged loans currently trade, or receive bids and offers, regularly.

The Loan Pricing Corporation (LPC), a division of Reuters, has held the pre-eminent public market data provider position for the leveraged loan market since its creation in 1985. In 1999, LPC teamed up with the LSTA to provide live dealer quotes online. Under the LPC/LSTA effort, dealers sought to promote greater investor interest in the market by regularly providing non-firm bids, in addition to actual traded prices.

But fund managers still have to price the remaining securities for which no market data is available. Existing methods for deriving values are inadequate, claimed LoanX chief executive Michael Rushmore, who is based in Chicago. Rushmore said, "They [investment managers] basically hold their thumb up in the air and say what do you think this thing is worth?"

LoanX, whose investors include Bank of America, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs and JP Morgan Chase, began posting secondary market loan price data from loan fund investment managers in Q3 2001, and began receiving dealer quotes in Q2 this year.

Rushmore said the idea for the joint venture with Standard & Poor's, called Standard & Poor’s Loans Evaluation Service, arose when investment managers approached him about deficiencies in the existing service provided by LPC.

"It is an unmitigated disaster - it is absolutely worthless," Rushmore claimed, regarding LPC's valuation methods for illiquid loans. An official at LPC declined to elaborate on the process behind its valuation method, but cited LPC’s wide use by market participants as proof of satisfaction with the service.

According to Rushmore, a key problem with LPC’s service is the reliability of its dealer “mark pricing”. Companies often have several tradable credit facilities, each with different terms. The complexity of details leaves some trading loans open to operational risk. According to Rushmore, LPC’s system for guaranteeing that dealer marks are assigned to the correct loan facilities is faulty. Rushmore said LoanX’s access to Standard & Poor’s Portfolio Management Data service, which receives information on loan facilities direct from dealers and buy-side firms, has helped LoanX avoid pricing inaccuracies. He added that about 20% of dealer quotes submitted regularly are discarded after being checked against the Portfolio Management Data service. An official at LPC stood by the sufficiency of its own database, which she said compared favourably with Standard & Poor’s Portfolio Management Data service.

In addition to the “dealer mark” data LoanX currently provides, the joint venture Standard & Poor's Loans Evaluation Service will incorporate research from the rating agency’s analysts, feedback from market participants and data from Standard & Poor’s credit indexes. S&P and LoanX both emphasise the important involvement of the JJ Kenny Evaluation Services group within Standard & Poor’s in the new venture. The group is noted for its evaluation of illiquid securities, especially municipal debt.

According to Rushmore, the largest user base for the new service will be prime-rate funds, which invest primarily in leveraged loans and other mutual funds, whose leveraged loan investments are capped at 10%.

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