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On the White Board - April 2009
Apr 15, 2009
New Loan Discount Curve Construction
Our current loan discount curves are built from par loans, which are defined to be loans with average bid at or over 90. However, since mid-Sept ’08, the majority of leveraged bank loans are trading much below 90. This poses a serious problem to the applicability of our loan curves.
The attached charts illustrate the percentages of USD and non-USD denominated leveraged first lien bank loans trading at or above 90 (par loans). Also shown are the percentages of the loans with average bid above their relevant SMi loan indexes average bid minus 10, minus 20, and minus 30, respectively. The SMi loan indexes are produced by Reuters Loan Pricing Corporation (LPC) Secondary Market Intelligence service, with US 100 referring to the 100 most widely held leveraged loans in US, and EU 40 Lev the 40 most widely held leveraged loans in EMEA (Europe, the Middle East and Africa).
To deal with this issue, we have been doing a major rework on our loan curves. The new curves are no longer centered around par loans. Instead, we will set dynamic floors with reference to the SMi loan indexes (SMi US 100 Lev, SMI EU 30 NonLev, and SMi EU 40 Lev). For low price loans (those loans trading below the price floors we set), we will build a separate set of curves, albeit with less granularity.
The vintage of the loans is now added as a dimension. Three cohorts shall be used: pre-bubble-peak, bubble-peak, and after-bubble.