June 21, 2022 - As volatility spiked to multi-year highs in the secondary loan market in May, LSTA secondary trading volume surged 21% to $79.6, the second busiest month on record. Of course, April was a weak comp, as secondary activity had declined to “only” $65.6B. But prior to the April lull, monthly trading volumes averaged a very robust $77.4B across the first quarter. In total, trade activity has surged to a record setting $377.4B across the first five months of 2022, up 10% over the same time last year. In comparison, S&P/LSTA Leveraged Loan Index (LLI) outstandings have increased 6.3% in 2022, to $1.43T. 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. To that point, when annualized, full-year secondary loan trading volume now projects to a massive $905.6B, a 16% increase over 2021’s record total.
While trading volume soared in May, the same could not be said for market breadth, which is measured by the number of individual loans changing hands during any given month. Prior to May, an average of 1,650 loans were changing hands monthly across 2022. That figure though, fell to a nine-month low of just 1,550 loans during April, as price volatility spiked to levels not seen since the height of the COVID-19 crisis. But we’ve seen this trend before – as prices decline sharply in the secondary market, volumes spike but traders cast a narrower net and concentrate their efforts on the larger, more liquid loans of the secondary – particularly during times of severe outflows. To wit, 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. As the broader markets seemingly reduced their rate hike expectations, the possibility of a new rate paradigm lifted returns across the fixed income (and equity) markets at the expense of the previously unflappable floating rate loan market. In total, the LLI plunged 2.6% in May, marking the lowest monthly return since March 2020. When the dust settled, average loan trading levels had declined almost 300 basis points (into a low-95 range) while the median trade price tumbled into a mid-96 context – a level not seen since the summer of 2020. And as expected, mark-to-market bid-ask spreads (on the traded universe of loans) widened out considerably alongside falling prices– with both the average and median bid-ask spreads increasing more than 30 basis points apiece, to 100 and 95 basis points, respectively. Furthermore, May trading activity triggered a five-percentage point increase in the percentage of loans trading in a sub-90 context, which expand to an 8% market share.
Now on to the good news, where the sub-80 price cohort of loans, which is a good marker for severe distress in the secondary, remained range bound in May at less than a two-percent market share. Furthermore, while the May sell-off in the secondary market was severe (and unexpected), most market participants believe that the loan market’s borrower base remains well capitalized, and as a result, do not expect default rates (which currently sit at near-record lows) to rise meaningfully until 2023/2024.