July 7, 2022 - The secondary loan market traded sharply lower yet again last month after the S&P/LSTA Leveraged Loan Index (LLI) fell 2.6% in May. In June, the sell-off meant that returns sank another 2.16. When combined, the May-June 2022 period produced a -4.66% return, the second-worst two-month tally in more than 10 years (the worst being Feb/March 2020 at -13.53%). Across the third quarter, loan returns plunged 4.45%, which sank YTD returns to- 4.55%; this was the second worst reading for any comparable period since the Great Financial Crisis. But as in all things in life, performance is relative, particularly today when rising rates, inflation, and the threat of economic recession has not led to any safe havens. Take the ultra-rate sensitive investment grade bond and 10-year treasury markets as examples, where YTD returns total -13.83% and -10.94%, respectively. Worse still, equities have plummeted almost 20% on the year, while high-yield bonds have run in the middle of the pack at -12.66%.
Back to June secondary loan market where market breadth remained decisively negative as price decliners took a 93% market share; to be fair, this actually was an improvement over May when 97% of the secondary traded lower. Average bid levels dropped by another 248 basis points in June, to 92.16, the lowest reading since the summer of 2020. In total, bid levels fell 544 basis points across the second quarter, and 645 basis points on the year. At the same time, the market’s average bid-ask spread ended June at 140 basis points, after widening 49 basis points during the quarter, and 65 basis points on the year. Furthermore, from a sector standpoint, each of the 32 industries represented in the LLI have reported losses this year. This tale of woe includes the two largest sectors, Electronics (-4.27% return) and Healthcare (-5.73% return), which, combined, represent 25% of total loan market outstandings. While the primary market didn’t close entirely across the second quarter, new issue volume fell hard in May prior to plunging in June. In turn, LLI outstandings contracted for the first time in 16 months, by more $11.6B, to $1.41T. Unfortunately, lower lending activity met head on with a reduction in visible inflows into the asset class. While CLO issuance appeared solid in May and June at a combined $26B, the same cannot be said for loan funds, which played a large role in diminishing the loan market’s outperformance over the last year. As we mentioned in this space last month. the loan market’s 17-month streak of positive inflows (from loan mutual funds and ETFs) came to a screeching halt in May as outflows totaled $4.3B. In June, that figure ballooned to nearly $6B. But the retail investor has proven to be finicky and might just return to the floating rate loan market during the second half of 2022 – if the economy holds on and rates continue to rise meaningfully. If so, loan mutual funds and ETFs would look to add to their $18B increase in AUM this year. But at the same time, second half CLO issuance is projected to fall well short of its first half run rate of $69B. Finishing the glass-half-full side, it’s possible that loans just might be considered the safe havens of the second half of year; after all, they are floating rate and, while there are some credit qualms, default rates are not forecasted to rise meaningfully in the near term.