January 23, 2020 - After recording consecutive record highs during the fourth quarter of last year ($211 billion) and again during the first quarter of this year ($212 billion), secondary loan trading volumes decreased 10% in the second quarter, to $191 billion. Volumes really tapered off during a lackluster/risk-off third quarter where trade activity fell to a five-quarter low of just $166 billion. But as price volatility picked up in the fourth quarter and managers once again chased yield, volumes improved 4% to $174 billion, according to the LSTA’s 4Q19 Trade Data Study. Also in the fourth quarter, par-plus trading volume climbed to a 29% share of total volume, a 14-month high, while just 21% of trade activity took place in a sub-95 price context. All told, secondary trading volume totaled a record $743 billion across 2019, a 4% increase over last year’s figure (matching the percentage increase in S&P/LSTA Leveraged Loan Index outstandings).
All is well that ended well in the fourth quarter. Following its worst monthly print this year (-0.45% in October) the S&P/LSTA Leveraged Loan Index (LLI) produced a risk-on induced 0.6% November return and an eight-month best 1.1% return in December. All told, fourth quarter LLI returns totaled 1.73%, which increased full-year 2019 returns to a three-year best 8.64%. Better still, the LLI 100, which holds the market’s 100 largest and most widely held terms loans, returned 10.65% on the year. But it’s not as if it was a smooth ride from start to finish, actually far from it. The loan market began the year with a broad based recovery in the secondary during January and February. Trade prices went on to rally an impressive 324 basis points (3.4%) off fourth quarter 2018’s oversold conditions. But the market pulled back in March when the Fed announced that rates would no longer be rising anytime soon. The weakness was short lived though, so we thought, as the rally continued through the first week of May. Then the headlines (and markets) turned their attention to the trade war following President Trump’s admission that the US would apply new tariffs on Chinese goods if a trade deal could not be reached (which it was not). The trade controversy and its implications for the global economy went on to set off a six month lull in the loan market where market value losses were reported during five of the next six months. As a result, total returns were limited to just 0.57% from May through October. But unlike the fourth quarter 2018 technically fueled sell-off where prices fell indiscriminately, a flight to quality trade dictated price action during most of the six month period. Managers, who became risk-adverse and skittish on credit, sold off lower quality names while bidding up the higher end of the market. But that trend reversed in November and much more decisively in December as managers became more aggressive in bidding up the lower-end of the market. December’s median trade price improved 25 basis points, ending the year at 99.5 – or 190 basis points higher than it began. At the same time, the median bid-ask spread (on the traded universe of loans) tightened six basis points, ending 2019 at 75 basis points – or 15 basis points tighter than it began.
On the technical front, new issue supply was mostly limited, with S&P/LSTA Leveraged Loan Index (LLI) outstandings rising by just $46.3 billion, or 4%, to $1.19 trillion in 2019. On the demand side, CLO issuance remained strong at $118 billion, but was down 9% from last year’s record total. Most troublesome though was the unrelenting outflows reported by loan mutual funds which totaled $38 billion across 2019. While December’s redemptions came in at a 14-month low of just $1.6 billion, outflows have been negative for 15 consecutive months for a grand total of $61 billion in lost capital. Finally, Loan Mutual Fund AUM currently stands at just $111 billion or a post-recession low 9% of LLI outstandings while CLO AUM totals a record $662 billion or 55% of LLI outstandings. From a fundamental perspective, it was a mixed bag as well. Even though the default rate crept lower in 2019 to 1.39%, the percentage of loans rated B- increased its markets share to 14%, a rise of four percentage points across the year. But at the same time, CCC market share remained flat at just 6%. LSTA Full and Associate Members can click here for the full analysis.