July 20, 2023 - Following a strong start to the year, 2Q23 LSTA secondary loan trading volume fell 17% to $176B. While a drop-off in second quarter trading activity has occurred during each of the past five years, 2Q23 volumes came in at a seven-quarter low, marking the first sub-$180B quarter in two years. And while monthly trade activity improved in June over April and May (rising 6% to $60.5B), it was the slowest June recorded since 2017. All told, 1H23 trade activity sat at a five-year low of $387B, 14% short of last year’s record first half, but also 6% lower than 2021 (which is a better comp). On the plus side, the Morningstar/LSTA Leveraged Loan Index has registered the strongest total return (6.5%) since the first half of 2009. The caveat here is that interest, not price appreciation, was the driver: 71% of the index’s total return was generated through interest income, as monthly interest payments increased to 74 basis points this year from an average of 35 basis points in 2022).
In looking back across the second quarter, monthly trading levels remained in a tight band (within 100 basis points of their highs and lows), which along with a lack of new issue and weaker demand, explains the lower trade activity. In truth, the market has lacked direction after experiencing a strong early first quarter rally, with price gains generally offset by losses. Despite rallying 80 basis points from May’s low-water mark to end June at 94.4, average trade levels fell almost 50 basis points across the second quarter. That said, the market’s median trade level, which increased 40 basis points during June’s rally, to 97.4, seems more indicative of where the secondary is trading. As an example, the percentage of trade activity at a price point of 98 or better increased to almost 50% in June. But at the same time, loans trading in a sub-90-range constituted a six-month high 20% share, which highlights the level of bifurcation in today’s secondary. Accordingly, as the LLI default rate climbed to 1.7% in the second quarter, distressed trading volume increased 29% to $6.5B, the highest level seen in more than two years.
Despite lower trading volumes, all was not lost during the second quarter, according to the LSTA’s 2Q23 trade data study, which highlighted several positive market trends. First, mark-to-market (MTM) median bid-ask spreads on the traded universe of loans continued to tighten, ending June at a 14-month low of 78 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 a 15-month low of 17 basis points. Third, median par settlement times fell to T+11, representing a 28-month low. Finally, June’s price rally has so far extended into July, which would mark the first two-month consecutive period of rising prices since February.
