March 23, 2023 - It’s been a rough go in March where volatility first spiked around the banking sector following the collapses of Silicon Valley Bank and Signature Bank. And just as markets were digesting the broader economic damage, Swiss authorities were forced to step in and cut a deal with UBS to acquire Credit Suisse, one of the 30 GSIBs – Global Systemically Important Banks. Meanwhile, after much speculation, the Fed this week announced another 25-basis point rate hike, and now finds itself juggling inflation pressures and maintaining financial stability across the banking sector. Closer to home, the BSL market has traded down roughly 150 basis points so far this month and is poised to print its first negative return in six months, according to the Morningstar/LSTA Leveraged Loan Index (LLI).
But that is now. February, the focus of this report, proved to be the quiet before the storm, as LSTA secondary loan trading volume fell 11% to $63.2B – the second lowest monthly tally since August. With just two months on the books, secondary activity is off 13% from the same period last year. At the same time, LLI outstandings again contracted in February; and after five consecutive months of decline, outstandings have dropped $30B.
Also notable in February: While the average price in the LLI declined, the median traded price of loans climbed 80 basis points, topping 98 for the first time since last April. There were several factors that drove the median trade price higher in February. First, after a busy first few weeks in the secondary, when prices continued to reach new highs, trade activity dwindled by 15% over the second half of February when the market reversed course and traded down. But more significantly, many portfolio managers became risk-adverse across February, in contrast to their more aggressive behavior that drove the loan market’s rally that began during the fourth quarter. As a result, traders bid up the higher end of the market, highlighting their preference to chase higher-quality paper that often trades much closer to par. As an example, despite February’s softer overall tone, loans trading at 98 or better constituted a 53% market share of trade activity, up 10 percentage points over January. Additionally, the flight to quality trade was made equally evident when assessing trade activity in terms of bid-ask spread. In February, the percentage of trade activity at a mark-to-market bid-ask spread of 50 basis points or less, doubled to 25%. At the same time, loans trading at a spread wider than 100 basis points saw their activity fall five percentage points to 24%. While the broader markets are still assessing the fall-out from the latest round of bank failures and loan managers are grappling with higher default rates, it looks like the market has swung from reaching for assets to fleeing to quality. We’ll see if this is a fad or whether it will be with us for the foreseeable future.