By Lisa Lee
NEW YORK (Reuters) - Declining volatility in the loan market has made the buying and selling of secondary paper easier, though higher-quality loan names are still in high demand and are experiencing tight liquidity, market sources said.
The loan market is in a period of relative calm after a stormy few months. In less than three months, the SMi100 composite - the 100 most widely-held loans - lost almost 2 points in the secondary market, with the average bid falling from 97.21 on December 1 to 95.3 on February 23, according to Thomson Reuters LPC data.
In a sharp reversal, those loans recovered and the average bid was back to 97.2 by March 22. Fast forward another month, and the average bid had been boosted almost one point more to 98.15, where they have been trading since.
During that volatile period, traders complained of difficulties with a lack of liquidity, meaning that executing a trade significantly shifted the price. The risk-on, risk-off market led to market participants wanting to make the same trade.
“When the market is falling, everyone wants to sell. When the market rallies, everyone wants to buy,” said a loan trader.
In March and April, tightening liquidity was compounded by the dearth of new primary loans coming into the market. The resurgent demand from new Collateralized Loan Obligation funds (CLO) and cross-over buyers overwhelmed the meager supply of loans, pushing secondary prices higher and making it more difficult to buy loans.
“When it’s risk-on, you can sell what you want, but nobody is selling quality credit. There’s more demand for those loans than sellers,” said a loan investor in April.
FALLING TURNOVER RATIO
In the loan market, the annual turnover ratio declined to 71% last year from 83% in 2014, according to industry trade group LSTA.
The turnover ratio is trading volumes divided by the average amount of S&P/LSTA Leveraged Loan Index Outstanding, and can be seen as a proxy for market liquidity. The LSTA projects that the ratio may fall below 70% this year, which would mark a 10-year low.
However, reduced volatility has tightened the bid-ask spread for the top 100 loans to 0.65 points by May 10, down from 0.9 in the middle of February.
Buyer appetite seems to have muted. There have been fewer CLO formations in May compared to a very active end of April, while flows to bank loan mutual funds have been modest -- leaving them neither strong net buyers nor sellers. In addition, high-yield bonds have seen a large cash exit, which may depress cross-over buying.
“Buyers don’t seem like they are rushing quite as quickly to put cash to work unless their hand is forced with an earnings release or paydown,” said another loan investor.
There does remain a race for the best-quality loans. With the financial market recovery feeling rather fragile, buyers are focusing on higher-rated loans.
“Liquidity isn’t giving us too hard a problem, but higher quality names will continue to remain tough to source,” said the loan investor.