March 17, 2022 - Following January’s flurry of secondary trading activity in the loan market (volumes spiked 48% to $76B), February volume increased another 3% to $78.1B. While this marked the second busiest month on record, February 2022 still fell well short of March 2020’s all-time high of $119B. February’s trading surged on a substantial increase in monthly market breadth, with a record 1,673 individual loans transacting in the secondary. In comparison, an average of 1,536 loans traded monthly across 2021. But clearly, volatility has driven trading volumes higher this year, and there has been a lot to be volatile about these days. While investors shifted their concerns from inflation and rates to Russia and the possibility of recession (and, still, inflation), the secondary loan market remained relatively stable in comparison to other asset classes during February. (This is true despite the March sell-off that had sunk S&P/LSTA Leveraged Loan Index returns to -1.3% by mid-month). That said, let’s not sugarcoat what occurred in February: 92% of loan prices declined while just 4% advanced in the secondary. In total, the monthly average and median February trade prices fell 39 and 25 basis points, respectively. Trading levels though, looked a bit softer at month-end than the monthly stats indicated. To that point, while the average February trade price printed at 98.83, the market was trading about 40 basis points lower during the last week of the month. Same for the average LSTA/Refinitiv mark-to-market bid-ask spread on the traded universe of loans, which widened 5 basis points to 55 basis points across February but increased to 65 basis points around month-end.
So why did volumes continue to spike in February while price declines remained relatively tolerable? First, while the loan market will rightfully trade off during times of macro contagion, the default rate remained at a near-record low (0.2%) and the three-month trailing downgrade/upgrade ratio continued to be bullish, at 0.74. Second, visible demand levels stayed elevated in February, despite the secondary sell-off that sent LLI returns into negative territory on the year. Case in point, after investors poured a record $9.7B into loan mutual funds and ETFs in January, flows totaled another near-$9B in February as floating rate assets continued to be in high demand (at least until outflows this week). Given that this money generally needs to be put to work quickly by fund managers, this record pace of inflows generated a floor on price declines in the secondary. And while CLO creation doesn’t give such an immediate impact on price support levels, CLO issuance came back to life in February at the tune of $13.7B. But then there are the existing CLOs, to the tune of $892B in AUM, which were said to be extremely active in the secondary as managers took advantage of lower prices to build par (e.g., acquiring lower-cost loans that still count as par assets, helping managers meet collateralization level requirements).
For more information on the secondary loan trading market, please contact Ted Basta.