When Morgan Stanley and Lehman Brothers quantified the knock taken to their leveraged lending business over the summer in their Q3 earnings statements, much was made of the figures: $726 million for Morgan Stanley and more than $1 billion for Lehman Brothers. But figures like this can disguise more than they reveal – and what the past couple of months have certainly revealed is how random marking to market becomes when there is a massive mismatch between demand and supply. The level at which loans are marked on the books of the arranging banks should be a reflection of the level at which they can be sold in the market. Activity in the LBO market revived in September, with loans being marketed – and successfully sold – at a discounted 96% of face value. Does this mean that the entire $300 billion LBO overhang should be – or is indeed being – marked on the underwriters’ books at 96?
Marking to market rather than accrual accounting in the leveraged loan market is a relatively recent phenomenon. And what has become readily apparent in recent weeks is that there are almost as many approaches to marking loan books as there are loan books themselves. There seem to be two schools of thought as to the approach the banks should now take: either mark very aggressively to get all of the bad news out of the way in an environment where it is expected or try to dilute the impact as much as possible.
But how do you accurately mark a book of thousands of loans when there are huge discrepancies between each one? Some banks aren’t even marking at all. For unrated loans, marking relies on fundamentals – and will likely show no justification for a discount as performance has not deteriorated. Benchmarking a loan book in these circumstances is certainly more an art than a science.
