The practice of underwriting banks coming out of syndication short on new debt offerings is slowly creeping its way into the loan market. Market players cited Goldman Sachs' second-lien term loan and floating-rate note for Calpine Corp. as the most recent example, and one buysider said more banks were adopting the strategy and coming out of syndication an average $5-10 million short. Coming "out of the box syndicate short" is commonly used in the bond market in an effort to assist liquidity and support the new deal, but is considered an anomaly in the loan market.
Here's how it works: A dealer will over-allocate a new issue, causing the need for the desk to cover that gap by buying up paper, creating a natural bid on the break. There is no repo market for bank loans, so banks need to quickly cover their shorts before allocations settle. The practice can get tricky if a deal trades down, because the bank is viewed as able to make a profit by buying at a discount. One dealer noted, however, that a desk trying to support the deal will use the profits made on a short to make sure its desk bids on the offered side of the market to boost the name.
To be sure, the practice is not rolling full steam ahead in the loan market. "If it is a tough deal, it's hard to over-allocate as people don't want the paper," one dealer noted. "If it is a hot deal, you don't want to over-allocate as a dealer as you don't want to be net short." Hunger for paper in the loan market at this time has made the practice virtually unneeded, as most new issues are very-well bid without dealers having to short the paper to ensure a natural bid. One buysider noted, "Deals are so wildly oversubscribed that desks don't need to use capital to support the credit."
Indeed, one dealer noted that when buysiders are eager to get their hands on paper, shorting can pit the underwriter against the customer. Recent deals his bank has led have blown out. "If we were to have shorted those deals, we would have just been competing with our clients for the paper in the secondary," he said. But in leaner times, dealers who use the strategy see it as an effective means to an end. "Our agenda is to make bank debt more like bonds, creating a liquid market," said one proponent of the practice.