July 21, 2022 - As volatility became elevated in the secondary loan market in first half of 2022, trading volume surged to record highs.  Across the first six months of the year, secondary activity swelled to $459B, a 12% increase over the same time last year and a 24% increase over 2H21, according to the LSTA’s 2Q22 Secondary Trade Data Study.  In comparison, S&P/LSTA Leveraged Loan Index (LLI) outstandings have increased just 5% in 2022, to $1.41T.  This year’s rise in secondary trading volume should not be understated as it is rare to witness the percent change in trading volumes tracking ahead of the market’s growth rate in outstandings.  While 1Q20 still holds the quarterly record for trading volume at $250B, 1Q and 2Q 2022 came close at $232B and $227B, respectively.  Furthermore, when annualized, full-year secondary loan trading volume now projects to a massive $918B, an 18% increase over last year’s record total.  In turn, the market’s annual turnover ratio (trading volume divided by LLI outstandings), would then rise 3 percentage points to 65%.  Of course, this year’s increase in trading volumes is a byproduct of the substantial sell-off in the secondary market (particularly during May and June), when trading prices declined to two-year lows. 

On to second quarter performance stats where market breadth remained decisively negative in June as price decliners took a 93% market share; to be fair, this was an improvement over May when 97% of the secondary traded lower.  Average monthly trade prices dropped by another 90 basis points in June, to 94.5, the lowest reading since the summer of 2020.  In total, trade prices fell 280 basis points across the quarter, and 450 basis points on the year.  At the same time, the average mark-to-market bid-ask spread on the traded universe of loans ended June above 100 basis points, for the first time in 20 months. All told, bid-ask spreads widened 19 basis points during the quarter and 46 basis points for the year.  Furthermore, the second quarter sell-off was evident in the distribution of trade activity by price range.  Since the end of March, the percentage of trade volume in a sub-90 price range increased seven percentage points to 9%, while volume priced at 98 and above tumbled 47 percentage points to just 14% of activity.  In turn, loan returns plunged 4.5% during 2Q22, sinking YTD returns to- 4.6% — 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 IG bond and 10-yr treasury markets as examples, where YTD returns total -13.8% and -10.9%, respectively.  Worse still, equities have plummeted almost 20% on the year, while HY bonds have run in the middle of the pack at -12.7%. 

Finally, we end with the market’s technical backdrop, where 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 nominally 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.  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 a fickle retail investor 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. (A hopeful sign: prices in the secondary have rallied 130 bps off their lows so far in July).  If those trends hold, loan mutual funds and ETFs might 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.

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