Feb

23

How many traders would choose to trade where:

1. Their counterparty to each trade also sets their margin requirements.

2. The counterparty to each trade knows the exact capital position and portfolio wide standing.

3. The counterparty to each trade is able to set prices on all positions in the portfolio as well as the current trade in times of stress. (Was this hidden deep in the swap confirm?)

4. Mass liquidation of the portfolio generates massive fees for ones counterparty, such that they have every incentive to push you in time of stress.

This is not retail forex, this is the status of things in many Leveraged Loan portfolios. While times were good, did any of these conditions seem like severe disadvantages? My guess is that these were the little details, overlooked in the rush to become involved in this "exciting" asset class that offered exciting diversification opportunities.

Portfolios in my group have in the last few weeks breached collateral tests that in essence triggered massive stop loss selling. In some cases (Rule 3 above) the mark to market pricing has changed: whereas in prior periods it has been done with a service like markit, now the price feed has been swapped, and wouldn't you know it, the pricing is just low enough (and always below markit) to trigger portfolio liquidation.

My prior view a few months back seemed more optimistic: Lower prices balanced by "strong hands" looking for value. Lately, it has not felt that way at all. Just massive selling.

Yet some adapt, rather than die. Conversion from total return to cash flow deals is a mutation that may allow those who adapt in similar fashion to hang on.

This is an ant level view, I am left wondering how these losses will play out in the larger picture.

I am not sure in which book or which writing it was, but I am reminded of the admonishment not to compete in a game where ones competitor had every possible cost and information advantage. Yet, it seems the competitor is often hidden behind a veil called "service provider" making it hard to distinguish when one is in such a position until the moment of stress, when it becomes clear.

Sep

27

The behavior of total return swap CLO deals over the last few months has been interesting. As the loans have been marked to market with deep discounts, huge stop loss orders have been triggered in the past few months.
 
Did the creators of these fixed-rule systems realize that they would cause forced liquidations at the worst possible moment? In essence, they piled a mountain of stop loss orders simultaneously at the same price levels. It is the old conundrum: If you trade your equity position in a leveraged trade (and not the market), how do you avoid being the weak hand? Buy high, sell low.
 
The indentures of individual portfolios map out coverage tests (margin requirements) that must be followed by the asset manager. If the tests are not met, a part of the portfolio must be liquidated until the portfolio once again passes coverage tests. It is all very sensible, a rational plan easily understood by investors who fear the leverage. They are protected from the possibly aberrant judgment of the asset manager.
 
Yet when masses of such tests are breached on many deals at once, the prices move to hurt the weak hands and pricing no longer seems rational beyond this internal logic.
 
As the weak flounder and unwind, the strong eat the weak. New structures are created with higher equity positions and firmer footing. The rejuvenating spirit of capitalism lives on.

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