New York - Participants and panelists at the seventh annual conference of the Loan Syndications and Trading Association (LSTA) in New York last week were proud to say that their asset class has survived prolonged market volatility far better than any other.
The floating rate nature and senior secured status of bank loans has served them well in these troubled times. Still, with more volatility and market uncertainty on the horizon for the foreseeable future, those attributes alone won't be sufficient to keep risk at bay and protect the loan market from the dramatic downturns experienced by its peer markets, namely equities and high yield bonds.
To ensure the continued positive performance of loans, market participants are going to have to do a number of things. Most importantly, they will need to "act like they're regulated," said Laura Unger, former acting chairman of the Securities & Exchange Commission. The hawk eyes of regulators are boring down on the financial landscape - indeed, the SEC is currently doing an inspection sweep of loan participation funds out of New York and Chicago, Unger said - and they are ready to descend upon suspect areas. The Financial Accounting Standards Board (FASB) and credit rating agencies have already issued new standards that players like CDOs need to abide by.
Regulation aside, though, the character of today's marketplace - one that has been whipped around by extreme volatility and corporate scandals - calls for participants to hunker down and follow some core principles. If buyside players and sellside firms abide by these, they will help to create a strong and healthy market, a market which, like Caesar's wife, is "above reproach," Unger said.
Value in valuation
At this time, transparency and valuation are key, and the driver of transparency is mark-to-market pricing, said Bank One's Marcia Banks.
"Mark-to-market is fundamental to the liquidity and development of the [loan] market," Banks said. The mark-to-market initiative has been a priority for the LSTA and over the past year, there have been many improvements in this area, in terms of available pricing information and lists of movers and shakers in the secondary market.
But at a time when valuation is key and mark-to-market pricing is crucial, there are still many challenges for the loan market and its participants. Indeed, there is still a lot of progress to be made in bringing together the two facets of valuation, the concepts of fair value and market value, said Ruth Yang, director of market data at the LSTA.
"You need to bridge the gap between internal fair value models and market value models by a third party," Yang said. "And for this effort, there's a continued need for dealer quotes, relative value models and trade data."
At this stage, dealer quotes are available and the market is starting to see some relative value models, Yang said. However, while the LSTA has been collecting trade data over the past few years, this information is not readily available. The value of trade data is primordial, though, Yang said, for the continued development of models as the next step in the loan market's maturation. The LSTA needs a reliable source of trade data for benchmarking in order to construct these models, Yang said, and continues to gather it from buyside and sellside firms.
Despite the obstacles to bringing about a uniform mark-to-market system, it is undeniably becoming the norm for the loan market.
"It's the tail that's wagging
the dog these days, it's what you've got to do," said Mike McAdams, chief investment officer
at the Los Angeles-based buyside firm Four Corners Capital Management, which is in the process of launching its first CLO.
In addition to mark-to-market, proper corporate governance is essential, and regulators will be looking for this, the SEC's Unger said.
Because investors have become so gun-shy, corporate integrity is becoming more significant.
"Integrity is key to investor confidence and investor confidence drives a healthy market," Unger said. "It is very tough to regulate integrity, but the best way is to make information providers more accountable."
There is also an ongoing need to educate investors on the way of the market, to show them that the act of investing does not always guarantee a return, Unger said. That said, acts of greed on the part of those who manage funds are wrong. Not only can they mislead people, but it has been proven that acts of greed have a far larger impact on the market than acts of terror, Unger said, and market recovery can only be delayed by the selfishness of a few.