A Well Deserved Breather?

July 11, 2017 - The loan market’s 15-month positive total return streak finally came to an end in June as the S&P/LSTA Leveraged Loan Index (LLI) posted a negative 0.04% return.  June’s negative 0.43% market value (MV) loss was the most severe since February 2016, which, not coincidently, marked the last time the LLI found itself in the red.  Across the second quarter, loans returned 0.76%, following first quarter’s 1.15%.  And at 1.91% through the first half, loan returns now trail each of the other major asset classes.  It truly has been a coupon-clipping year so far in 2017 as bid levels have fallen six bps since year-end (four bps off their low but 60 bps off their early March high).  That said, it has been rough sledding in the secondary this year, and more so lately, as MV returns have been negative for two months running and three times since March.  Moreover, during June, market breadth turned decisively negative as 64% of loans reported MTM losses in the secondary while just 20% reported gains.  In turn, average bid levels fell 31 bps to 98.02 while the median bid fell 10 bps to 100.08.  While June might have been the breather the market was looking for, the secondary remained historically rich with 54% of loans still bid above par.

A trifecta of events were said to take the market lower in June.  First off, issues in the oil patch resurfaced (WTI traded down to 10-month lows on renewed oversupply concerns) which sank Oil and Gas loan returns to a 17-month low of negative 3.92%.   Second, at negative 1.5%, the retail sector reported its worst monthly return in 20 months.  Not coincidently, AMAZON had announced its purchase of Whole Foods mid-month as the online behemoth attempts to now wreak havoc on brick and mortar grocery stores.  Third, the market’s technical backdrop changed course in a major way.   In terms of supply and demand, the paradigm finally shifted after 15 consecutive months where CLO issuance and Loan Mutual Fund Flows combined to outpace net new issuance.  In total, new visible demand levels trailed net new issuance by a staggering $20 billion.  On the supply side, LLI outstandings (including unpriced loans) grew by a record $34 billion in June - to a fresh high of $943 billion, according to LCD.  And CLO managers welcomed the influx of new paper, particularly considering that $13.7 billion of new CLOs were issued – a 27-month high.  But at the same time, Loan Mutual fund inflows continued their decline in June by totaling a 12-month low of just $215 million.  Maybe retail investors were watching the default rate, which crept back above 1.5% for the first time since January, as opposed to short-term interest rates – where 3-Month LIBOR hit 130 basis points.  Either way, June’s technical dislocation might have represented the buying opportunity of 2017 as the market is already trading higher in July - following that well deserved breather.        

LSTA Full and Associate Members can access the full Summary, including charts, here (located under Secondary Market Monthly).  For more information, please contact Ted Basta.

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