Trading hampered as buyers flee to crowded exits

BlackRock, Ares

BlackRock Inc., Ares Management LLC and other firms have refinanced more than $2 billion of CLOs this year, and an additional $8 billion sold in 2011 will be able to cut interest payments by the end of 2013, according to Royal Bank of Scotland Group Plc. Restrictions preventing more than $40 billion of 2012 investments from doing the same will be lifted in 2014, according to the bank.

In emerging markets, relative yields widened 7 basis points to 354 basis points, or 3.54 percentage points, according to JPMorgan’s EMBI Global index, which has averaged 302.4 this year.

Daily trading volumes in high-yield bonds have decreased to $4.3 billion on average this month through Aug. 19, compared with $5 billion in the corresponding period in 2012, Trace data show. Investment-grade volumes fell to $9.8 billion from $10.5 billion.

The decline marks a reversal from the first five months of this year, when average trading volumes for debt of corporate borrowers from the riskiest to the most creditworthy of $19.4 billion were 8% higher than last year’s pace.

Fund Outflows

While market turnover has, if anything, increased since the financial crisis, “liquidity is about much more than turnover” and has the “tendency to disappear abruptly when really needed,” according to a presentation to the Treasury Borrowing Advisory Committee that sought to assess liquidity in the fixed- income market.

Buyers pulled $7.4 billion from investment-grade funds in July, Bank of America Corp. data show, after Fed Chairman Ben S. Bernanke said the central bank could start curtailing the current pace of debt buying if growth is in line with central bank estimates. The Fed will likely reduce the central bank’s $85 billion in monthly bond purchases next month, according to 65% of economists surveyed by Bloomberg.

A 2.8% loss this year on dollar-denominated corporate debt compares with a 7.1% gain in the corresponding period last year, Bank of America Merrill Lynch index data show.

$5.3 Trillion

Corporate borrowers racing to lock in borrowing costs that averaged 4.3% as of Aug. 19, compared with a 10-year average of 5.82%, have sold $975 billion of the debt this year, expanding the size of the market to $5.3 trillion, according to Bloomberg and Bank of America data.

BlackRock’s $17.8 billion investment-grade bond ETF has eliminated 7.3 million shares this month, equal to about $825.6 million, data compiled by Bloomberg show. Its $14.6 billion high-yield ETF reported an outflow of 3.6 million of shares on Aug. 19, the biggest daily withdrawal on record.

“We expect outflows to accelerate,” Bank of America credit strategists led by Hans Mikkelsen in New York wrote in an Aug. 19 report. “With poor summer liquidity and hedging needs we retain our hedge against a disorderly rotation with wider credit spreads.”

Wall Street dealers traditionally act as middlemen by warehousing bonds until customers seek to buy them. That model is changing as U.S. and international rules meant to make the banking system safer have prompted dealers to cut the amount of debt they hold.

Risk Concentration

The 21 primary dealers that do business directly with the Fed reduced their balance sheets to $56 billion at the end of March from $235 billion in October 2007, New York Fed data show. They were holding $7.9 billion of investment-grade bonds as of Aug. 7, Fed data shows, about 0.2% of the market for the dollar-denominated notes.

That’s led to a concentration of credit risk in funds that take bullish positions on corporate debt, leading to more of a one-sided market than in the past, Citigroup credit strategists led by Antczak wrote in a report this month.

Goldman Sachs spent a year developing an electronic trading system for corporate bonds called GSessions that started operating in 2012. UBS, Switzerland’s biggest bank, has directed more debt trading onto its Price Improvement Network, which lets customers directly post prices with a so-called order-book model where bids and offers are shown before the trade.

While there’s been “massive growth” in electronic price inquiries, much of it is small in size, leading to little extra depth in trading, according to the Treasury Borrowing Advisory Committee report.

“Liquidity has deteriorated overall,” Barclays’ Meli said. “Transaction costs remain high. In periods of low liquidity, the cost of transaction goes up more than we used to see in similar periods before 2011.”

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