01/21/2011

BofA, Citi Draw Flak for Trading Tactics

Bargain hunters are grumbling that Bank of America and Citigroup have been stepping in at the last second to buy pieces of their own clients' bid lists — but many market players say there's nothing wrong with the practice.

The complaints, from investors and smaller broker-dealers, focus on apparent purchases by the banks of collateralized loan obligation paper they were hired to pitch on the secondary market. The problem: In some instances, those same securities are quickly reappearing in the institutions' own for-sale inventories at higher prices.

Sources say that amounts to front-running by BofA and Citi. That is, the banks are accused of engaging in the frowned-upon practice of using bids from would-be buyers to spot potential discounts for themselves and then attempting to flip the paper at a profit.

However, other industry players argue that BofA and Citi have no choice but to take down their clients' offerings when bids arrive too low. Those individuals characterize the complaints as sour grapes from investors whose lowball prices were rejected, noting that the banks have to fulfill their functions as market makers.

Take a $2.7 billion package of CLO paper that hit the secondary market on Jan. 14, fetching offers of 70-70.5 cents on the dollar. An executive at a smaller broker-dealer claims the lead bank — he wouldn't specify whether it was BofA or Citi — informally notified him that one of his customers had won the auction. But the sale was never finalized, and within a day, the bank itself was offering the securities at 72 cents.

It could be that the higher price would represent a profit for the bank. Or perhaps the 70.5 cent bid simply fell below what the shop suggested to buyers. Indeed, such institutions often attempt to keep sellers happy by stepping in when predicted values fail to materialize. And it's typically policy at big shops like BofA and Citi not to jump in front of investors who adhere to price guidance. “If we pass . . . reputationally, we're penalized for not being a good liquidity provider,” a trader at another investment bank said.

That source said his bank only receives offers on about half of the collateralized debt obligations it puts out for bid each day, often from buysiders who want to pay well below what the sellers are expecting. He added that with offers typically arriving at 1/4-7/8 of a cent below asking prices, any proposed discounts of more than one cent on the dollar are automatically shot down. “If we do show them those lowball bids, then we're not going to get that customer's business again,” he said.

Rising values could be at the core of the dispute. After holding steady in November and December, secondary-market spreads for senior CDO securities have tightened by 10-20 bp each week since Jan. 1, with 6-8 year product now trading at 190 bp over Libor. Junior bonds have tightened as much as 150 bp each week, with 10-12 year paper with double-B ratings going for 750 bp over Libor.

The upshot, one trader said, is that investors who lack up-to-date analysis are bound to submit uncompetitive offers. He added that in those instances, the buyers are typically asked to come back with higher bids.” If you're looking at where the market was in December, you're not going to know where prices are today,” the trader said.

Another trader said accusations of front-running always surface when values are climbing.

Meanwhile, the players whose bids were rejected contend that it's easy for banks to hide behind their market-maker positions when acting in their own interests. Echoing a sense of distrust that broker-dealers often express about their bigger competitors, those sources add that there's virtually no way to tell when the institutions' actions are on the level. “They can easily come up with a reason why they bid more for it,” one said.

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