September 28, 2022 - Though September has been challenging – to say the least – late summer was relatively uplifting in the secondary. Following a challenging two-month stretch where loans sold off sharply, prices rebounded in July and rallied further in August. Alongside the August price rally was a slight pickup in secondary trading volume, which increased 5% to $60.6B.  That said, during the “rebound period” of July and August, volumes averaged just $59.1B per month, as compared to $76.2B across the “sell-off” period of May and June – a decline of nearly 30%.  This is not a new trend though; we’ve witnessed the market operate this way before.  As downward price volatility dissipates in the secondary, trade activity slows.  And then, tacking on the normal late-summer trading slowdown, it wasn’t too surprising that combined July and August volumes hit a one-year low for any consecutive two-month stretch.  While volumes have trended lower so far in the third quarter, full-year 2022 trade activity is still tracking to a record $853B- an increase of almost 10% over last year.  In comparison, Morningstar LSTA Leveraged Loan Index (LLI) outstandings are up 7% so far in 2022.

While trading volumes were unimpressive in July and August, the change in market breadth was significant. During the May-June 2022 period, advancer and decliner percentages averaged 3% and 95%, respectively.   But across July and August, 77% of loan prices advanced, while just 19% declined.  In turn, the market’s average trade price once again approached a 95-handle across August (a 3-month high) while the median trade price hit a four-month high of 96.75.  The same trend was not seen in bid-ask spreads though, where average (113 basis points) and median (100 basis points) spread levels remained at or near their two-year wides.  Heightened price volatility and wider bid-ask spread levels might just define the rest of the year as fundamental conditions aren’t looking too supportive of a sustained rebound in secondary prices.  Already, LLI returns are back in the red in September at negative 1.73%, with just three trading sessions left to go.  But let’s get back to those fundamental conditions where we have already witnessed a slight chink in our armor.  During August, the LLI’s default rate increased from 0.43% to 0.69% (by issuer count) but remains well inside its historical average of 2.43%.  Furthermore, while there may be a runway before defaults are problematic. Case in point, the trailing 3-month rating downgrade/upgrade ratio has worsened from 1.32 to 1.89 over the past three months – but remains far below the 43:1 ratio seen in the depths of Covid.  Ending the conversation on the glass-half-full side, B- market share (less than 24%) has not budged over those last three months, nor has CCC market share, which ended August at just 4.15%.