Upbeat Signs on Secondary Loan Liquidity Lie Below Surface

Liquidity held steady last year in the secondary market for commercial loans that banks syndicate to institutional investors, according to a survey by the Loan Syndications and Trading Association.

The dollar volume of leveraged loans that changed hands in 2012 fell slightly. Yet other measures of liquidity, such as the percentage of loans that traded (the market's breadth) and the frequency of trades (its depth), improved slightly, the survey found.

Twenty-one of the largest buy-side and sell-side member institutions of the LSTA supplied trade data for the survey.

Volume of $396 billion was down 3% from 2011, the survey said. It was the first sub-$400 billion year since 2006, but it ended on a strong note. Secondary trading volume rose 13%, to $100.5 billion, in the fourth quarter from the third quarter.

Another upbeat sign was the market's ability to overcome the damage caused by Hurricane Sandy in the New York area in late October and produce a strong final quarter.

LSTA officials focused on the importance of the improvement in market breadth and depth compared with 2011. For example, 51% of the loans on the market traded in the fourth quarter of 2012 compared with 46% a year earlier. And 32% of loans traded 5 to 19 times in the fourth quarter, up from 29% a year earlier.

An average of nearly 1,100 individual loans traded in each month of the year.

Lower price volatility in the secondary market contributed to the stronger liquidity, said Ted Basta, the senior vice president of market data and analysis at LSTA.

Prices rallied, and bid-ask spreads tightened for most of the year. The average trade price increased 4.6% over 2011, to 97.22 cents per dollar of face value; the median trade price rose 2.6%, to 100.25 cents.

"We've seen [price volatility] come down pretty substantially, generally speaking, after last summer when the market became very volatile in the June-to-July period," Basta said. "Sentiment is on the up and up. We're not seeing up and down gyrations."

A tremendous amount of demand for loans has created a rather strong technical bias to the upside, and this has boosted prices in the secondary market for the better part of the last seven months, he said.

Collateralized loan obligations, the most important buyers of loans before the financial crisis, are once again playing a big role in both the primary and secondary loan markets. In 2012, $54.4 billion of CLOs were issued.

CLOs are actively managed: for the first few years of their life, managers can buy and sell loans used as collateral. The diversity of CLO managers is also contributing to liquidity, Basta said. A total of 65 management companies did 117 deals last year.

"Looking at the buyer base is extremely important," he said. So far in 2013, he said, seven managers have already done 16 deals for more than $9 billion.

Loan participation mutual funds have also been attracting large sums. This sector pulled in more than $12 billion in 2012, roughly the same amount as seen in 2011, Basta said. Total assets under management in loans, which is a function of new money and price appreciation, increased to $91 billion from $70 billion at the end of 2011.

"There has also been tremendous interest coming out of the pension fund community, and going forward we are anticipating an increase in loan demand from this sector," Basta said.

Another factor that bodes well for the sector is the minimal amount of volatility in loan returns. According to the Standard & Poor's/LSTA Leveraged Loan Index, 12-month volatility of returns currently stands well below 1%, at 0.67%. This makes loans returns less volatile than other asset classes such as equities, which that are now almost five times as volatile.