October 19, 2023 - According to the LSTA’s 3Q23 Trade Data Study, secondary loan trading volume fell 7% to $164 billion, the lowest quarterly reading in three years. While a drop-off in third-quarter trading activity is always to be expected, we note that 1) 2Q23 trading volume contracted 17% to what was then the first sub-$180 billion quarter in two years and 2) 3Q23 volumes were down 12% from the same period last year – so the slowdown wasn’t just seasonal. Seasonality aside, secondary trading volume has been in steady decline since March, with 2023 annualized activity (through September) of $735 billion representing a five-year low, or an 11% drop-off from last year’s record total.
So why have secondary volumes fallen so hard and fast this year? It all goes back to supply and demand, according to traders and PMs who spoke on this very topic at last week’s LSTA Annual Conference. On the demand side, CLO issuance was off roughly 30% year-over-year through September. Additionally, a portion of existing CLOs have been far less active in the secondary with an estimated 28% share operating outside their reinvestment period. Last year, that figure stood at just 11%. Furthermore, monthly retail fund flows have been far weaker this year on an absolute basis (i.e., ignoring the direction of the flows). Last year at this time, absolute retail flows averaged $5.5 billion per month compared to just $2.2 billion in 2023 – a rather large difference when considering the effect of retail forced selling (or buying) on aggregate trade activity. Finally, on the supply side, 1Q23-3Q23 leveraged lending activity decreased 23%, thus limiting the ability of portfolio managers to actively search out “relative value” trades – another key driver of secondary activity.
All was certainly not lost during the third quarter, as the Morningstar/LSTA Leveraged Loan Index continued its hot streak by registering the strongest quarterly total return (3.5%) in three years – which drove the YTD return above 10%. Looking back across the secondary, there was a lot that was encouraging, that is until prices began to soften in late September and early October. That said, monthly trading levels surged more than 200 bps in the quarter, to an average trade price of 96.5. Even more impressive, the median trade price rallied to a 99-handle, a level not seen since last year’s first quarter. In turn, par-plus trading activity increased almost three-fold (to a 13% market share) during the third quarter. A direct beneficiary of this stronger bid secondary was the primary market, which saw institutional lending activity increase to the highest level since the Fed began raising interest rates some 18 months ago.
In conclusion, the LSTA’s trade data study highlighted several additional positive market trends. First, LSTA/Refinitiv mark-to-market (MTM) median bid-ask spreads on the traded universe of loans continued to tighten, ending September at a 17-month low of 67 basis points. Second, MTM price accuracy (as measured by the differential between trade and MTM prices on trade date), continued to improve; with the median differential falling to an 18-month low of just 16 basis points. Third, the quarterly median par settlement time fell to T+12, one day shorter than reported during the first half of 2023. Finally, while September’s trade activity totaled just $58 billion, monthly activity seemingly bottomed out in July, before rising 6% in August and 7% in September.