June 27, 2019 - After averaging more than $68 billion during each of the previous three months, secondary loan trading volume decreased 10% in May, to an eight-month low of just $61 billion. Moreover, that three-month period had followed three record setting months (November through January), where volumes spiked to an average of $74 billion per month. The common theme, of course, is a strong correlation between price volatility and trade activity in the secondary loan market. Price volatility (to the downside) peaked alongside trading volume during the technical sell-off that occurred late last year and again to the upside during the early 2019 recovery period. In fact, January set records with more than $76 billion in loans changing hands. But since the end of February, price volatility and trading volumes have declined in unison as bid-ask spreads ground tighter while prices ran mostly higher. Case in point, from its six-month low (December) through its high (May) the average trade price increased 140 basis points (bps) to 97.7, while the average mark-to-market bid-ask spread (on the traded universe of loans) tightened 25 bps to 73 bps. May performance though, contributed to those figures by just four and two bps, respectively. In comparison, during the previous five months, average prices and bid-ask spreads were moving by 33 and 10 bps per month, respectively.
That all said, another conceivable reason for the May “slow down” revolved around technical flows. First, the primary market became energized in May and took on a greater emphasis for traders as the S&P/LSTA Leveraged Loan Index (LLI) reported a $9 billion increase in new money loans, the biggest growth in three months. While hardly an outrageous number, it’s worth noting that LLI outstandings had previously increased by just $2 billion since the end of February. Second, CLO issuance came in at a five-month low – just short of $10 billion. Lastly, loan mutual fund outflows decreased to a seven-month low of “just” $2.4 billion (less selling). While it’s encouraging that selling pressure from loan mutual funds has moderated, May still marked the eighth straight month of loan mutual fund outflows. But there is a silver lining in the wake of the outflows and the subsequent higher level of volatility – a sizeable step forward for liquidity. Consider this: Since October of last year (which also marked the most recent high water mark for secondary prices), trading volumes averaged north of $69 billion per month. When annualized, volumes over the eight-month period would total more than $828 billion, or 15% higher than 2018’s record setting $720 billion. But as we are fully aware, the market is larger today than it was last year, so volumes should, of course, be higher. For that reason, we provide our turnover ratio (trading volumes/divided by the size of the LLI) which improved to 73% (on an annualized basis) over the past eight months. Today’s 72% ratio represents a five-year high and a three percentage point increase from the average annual ratios reported since 2015.
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