September 4, 2019 - Secondary loan trading volume totaled just north of $61 billion in July – a 10-month low. July marked the third consecutive month where volumes have stagnated; not rising above $61.3 billion per month. During the three months prior (February through April) the market averaged over $68 billion of trading. Of course, volumes usually taper off in the summer months, but there’s more to the story this year. First, price volatility has normalized. Since May, the absolute change in the average bid level of the S&P/LSTA Leveraged Loan Index (LLI) averaged just 33 basis points per month as compared to the 99 basis point absolute change registered from February through April. And the connection between volatility and liquidity becomes even more pronounced when you consider the three-month period ended January 2019. Here, monthly volumes and absolute bid change averaged $73.6 billion and 212 basis points, respectively. Second, visible demand has been constrained by nine consecutive months of mutual fund outflows; assets under management (AUM) have shrunk by $42 billion –and the contraction in AUM has been accelerating. Third, the new issue market has been relatively quiet, hence far less loans to trade on the break. To that point, LLI outstandings increased by just $8 billion since the end of April, which marked the weakest three-month growth period since first quarter 2017.
While trade activity remained muted in July, the market finally caught a strong bid after reporting negative returns in May and June. During July, both the average and median bid level climbed 25 basis points to 97.36 and 99.38, respectively. At the same time, the average and median mark-to-market bid-ask spread tightened five basis points to 69 and 46 basis points, respectively. Bid levels remain roughly 30 basis points off their 2019 highs, but bid-ask spreads sit at their 2019 tights. Trade activity at price points of par and above also hit its higher water mark in July, rising 18 percentage points to a 26% share. That all said, while the market generated a three-month best 0.8% return in July, August was a far different result. Prices in the secondary pulled back almost 80 basis points in August, leading to a -0.27% return, the worst so far this year. Even though loan returns have been negative during three of the past four months, the LLI still sports a year to date return of 6.3%. But loan returns trail the US equity and fixed income markets by a sizable margin and given the expectations of further interest rate cuts, the opportunity for loans to outperform may have diminished.