Staff Q3 2016 report on corporate bond market liquidity

Summary

This report1 describes developments in the liquidity and functioning of corporate bond

markets from July 1, 2016, through September 30, 2016. In this update, we use the same

measures of liquidity used in the previous reports for both primary and secondary market

conditions. The main findings are:

1) On balance, liquidity in the pnmary market- as indicated by the pace of primary

corporate bond issuance- continued to be ample in the United States, despite a notable

but brief slowdown in early July following the outcome of the U.K. referendum on June

23 regarding exit from the European Union. Both investment- and speculative-grade

corporate bond issuance volumes in Q3 stood comparable to the volumes for the same

period in 2015. Relative to Q2, however, a larger portion of speculative-grade issuance

in Q3 was earmarked for refinancing than for funding of M&A activity. This trend may

be the result of firms opportunistically borrowing at historically low rates. During Q3, on

net, yields on both investment- and speculative-grade corporate bonds declined to

historically low levels along with those on comparable-maturity Treasury securities.

2) Measures of secondary bond market liquidity that reflect the ease and cost with which

investors can buy and sell corporate bonds improved slightly in Q3 as a whole. The

average daily trading volume for both investment- and speculative-grade bonds remained

at the higher end of the ranges observed over the last five years, while the average daily

1 This report has been agreed to by the staffs of the Office of the Comptroller of the CuiTency, the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodity Futures Trading Commission (such agencies, collectively referred to as the Agencies). The Agencies have expressed no view regarding the analysis, findings, or conclusions contained in this report.

trading turnover2 for both investment- and speculative-grade bonds fluctuated around a

level typical for the past five years. 3 After adjusting for seasonal patterns, average bid-

ask spreads for investment-grade bonds narrowed a touch on net since the last report,

standing lower than the average since 2010. The average bid-ask spreads for speculative-

grade bonds were little changed, fluctuating below the levels observed during the first

half of the year. The fraction of trades with large face value - at least $1 million - and

the average size of such trades for investment-grade bonds were both little changed,

while those for speculative-grade bonds declined slightly from their Q2 levels. However,

both the fraction and size of these trades remained generally within the ranges that have

prevailed over the past few years. Meanwhile, reversing the downward trend observed in

recent years, dealers' inventories of corporate and foreign bonds increased slightly in the

second quarter of 2016 (latest data avai lable) but remained near their lowest levels over

the past decade.4

2 The average daily trading turnover is a measure of trading volume relative to the face value of bonds outstanding. 3 See Exhibit 2, "Trading Volume and Turnover (Seasonally Adjusted)." 4 "Corporate and foreign bonds," as defined in the Federal Reserve 's Financial Accounts of the United States,

includes, in addition to bonds issued in the United States by U.S. corporations and foreign corporate and sovereign entities, a ll other fixed income instruments (excluding syndicated loans) that are issued in the United States, such as privately-issued mortgage backed securities.

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I

2005 2006

Exhibit 1

Corporate Bond Liquidity Monitor

Gross Issuance of Nonfinancial Corporate Bonds Billions of dollars -

Quarterly

-CJ Investment Grade

• Speculative Grade*

Q3

-

-

I

2003 2004 2005

*Includes unrated bonds. Source: Mergen!.

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Ten-Year BBB Bond Yield and Spread to Treasury* Percent

10

9

8

7

6

5

Sept. 4

3

350

300

250

200

150

100

50

0

7

6

5

4

3

2

Monthly

Yield (right scale)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

*Estimated from curve fit to Merrill Lynch bond yields. Treasury yields from smoothed yield curve estimated from off-the-run securities. Within-month average value.

Source: Staff Calculations.

Use of Proceeds tor Speculative Grade Issues* Billions

80 Quarterly

General Purposes•

M&A 60

al aton

Refinancing

40 Q3

20

0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

*General Purposes includes capital expenditures and other purposes not included in the designated breakdown. Source: Standard and Poor's.

0

Exhibit 2

Corporate Bond Liquidity Monitor

Number of Traded Bonds as a Fraction of Total Disseminated* Percent of Par

5-day Moving Average

Sept. 30

2006 2008 2010 2012 2014 2016

*Only trades of bonds that have been issued for 60 days or more at the time of trading are included. Excluding 144a bonds. Source: FINRA, Mergen!, Moody's DAD.

Trading Volume and Turnover* (Seasonally Adjusted) Percent

200 5-day Moving Average Volume

(right scale) Turnover160

120

80

40

(left scale)

Billions of dollars

Sept. 30

2006 2008 2010 2012 2014 2016

*Only trades of bonds that have been issued for 60 days or more at the time of trading are included. Excluding 144a bonds. Note: Turnover series is annualized by multiplying the daily turnover with 251. Source: FINRA, Mergen!, Moody's ORD.

30

25

20

15

10

30

24

18

12

6

0

Trading Volume per Disseminated Bond by Rating (Seasonally Adjusted)* Thousands of dollars

1800 5-day Moving Average

1500Investment Grade

Speculative Grade

1200

900

600

300

0 2006 2008 2010 2012 2014 2016

·only trades of bonds that have been issued for 60 days or more at the time of trading are included. Excluding 144a bonds. Source: FINRA, Mergen!, Moody's ORD.

200

160

120

80

40

0

Percent of Par

5-day Moving Average

last report

2014 2015 2016

Percent Billions of dollars

5-day Moving Average

I

2014 2015 2016

Thousands of dollars

5-day Moving Average

last report

~ '· '~ I

~wt..·"~._1 J~·~ ~ I I

~ i

2014 2015 2016

30

28

26

24

22

20

18

30

24

18

12

6

0

1800

1500

1200

900

600

300

0

Exhibit 3

Corporate Bond Liquidity Monitor

Bid-Ask Spread for All Bonds* Percent

5-day Moving Average Investment Grade

Speculative Grade

2005 2007 2009 2011 2013 2015

Bid-Ask Spread for All Bonds* (Seasonally Adjusted)

5-day Moving Average Investment Grade

Speculative Grade

Percent

2005 2007 2009 2011 2013 2015

Bid-Ask Spread for Investment Grade Bonds* Percent

Sept. 30

5-day Moving Average Financial

Non-Financial

2005 2007 2009 2011 2013 2015

·All measures are computed for non-defaulted bonds on the secondary market that have traded at least 10 times between 10:30am and 3:30pm. Excluding 144a bonds. Bid-Ask spread is the difference between weighted average dealer bid prices and ask prices.

6

5

4

3

2

0

6

5

4

3

2

0

4

3

2

0

Percent

5-day Moving Average

last report

2014 2015 2016

Percent

5-day Moving Average

last report

2014 2015 2016

Percent

5-day Moving Average

2014 2015 2016

3.0

2.5

2.0

1.5

1.0

0.5

0.0

2.00

1 . 75

1.50

1.25

1.00

0.75

0.50

1.5

1.4

1.3

1.2

1.1

1.0

0.9

0.8

0.7

0.6

0.5

Exhibit 4

Corporate Bond Liquidity Monitor

Percentage of Trades Greater than 1 Million in Par Value* (Seasonally Adjusted) Percent

45 5-day Moving Average

40Investment Grade

Speculative Grade 35

30

25

20

15

10

5

0 2006 2008 2010 2012 2014 2016

*Only trades of bonds that have been issued for 60 days or more at the time of trading are included. Excluding 144a bonds. Source: FINRA, Mergent, Moody's ORD.

Percent

5-day Moving Average

last report

'I ~.)'to. ~ ,;

.• ,~ ·w !f.'/11. l~ ept.'1 3

2014 2015 2016

45

40

35

30

25

20

15

10

5

0

Average Size of Trades that are Greater than 1 Million in Par Value* (Seasonally Adjusted) Millions Millions

7 5-day Moving Average 5-day Moving Average

Investment Grade

Speculative Grade 6 last report

5

4

3

2

2006 2008 2010 2012 2014 2016 20162014 2015

*Only trades of bonds that have been issued for 60 days or more at the time of trading are included. Excluding 144a bonds. Source: FINRA, Mergent, Moody's ORD.

Broker-Dealer Holdings of Corporate and Foreign Bonds* Billions

02

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

*Series FL663063005.Q. Aggregate holdings of U.S. corporate and foreign bonds by U.S. domiciled security brokers and dealers. It includes all other fixed income instruments (excluding syndicated loans) that are issued in the United States, such as privately-issued mortgage backed securities. Source: Federal Reserve. Financial Accounts of the United States.

7

6

5

4

3

2

420

380

340

300

260

220

180

140

100

60

20