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Hot-ober Loan Market: No Tricks, Just Treats for the Secondary

November 8, 2017 - While there’s been a softer start to November (HY bond and loan prices are already down 61 and 6 basis points, respectively), October was different. The secondary loan market finally caught a sustained bid last month as the S&P/LSTA Leveraged Loan Index (LLI) returned 0.6%.  Not only did October returns represent the second best performance on the year, they marked the first time returns were in the black for two consecutive months since May (September returns totaled 0.4%).  While hard to believe given the strong market backdrop but, market value returns were positive in October for the first time since July and just the second time since April – or just twice in seven months.. And despite the strong October showing, year-to-date market value returns remain in the red for double-B (-0.6%) and single-B (-0.68) rated loans.  To that point, it’s been nearly impossible to outperform the benchmark this year unless a portfolio manager was overweight the Sub-B rated portion of the market, which stands at just 6% of market value outstandings.  

October also saw market breadth improving for the third consecutive month.  In total, 66% of LSTA/Thomson Reuters LPC Mark-to-Market (MTM) loan prices advanced in October with just 24% declining.  October’s advancer-decliner ratio of almost 3:1 was the most bullish since July’s 3.6:1.  Even more impressive, nearly 10% of loans recorded MTM gains of better than 1% during the month.  In turn, average bid levels increased 20 basis points to 98.16 following two months of languishing in a sub-98 context.  But as we’ve said numerous times in this space, the average is misleading given that 64% of loans were bid above par by October’s end, an increase of six percentage points across the month.  

Once again, the resurgence in par-plus market share centered on technicals, where “excess demand” totaled more than $13 billion – a three-month high.  October CLO issuance of $12.8 billion was the source of the excess demand as loan mutual fund flows continued to be immaterial.  Net supply also was immaterial, as LLI outstandings edged down by $250 million. Worth noting: As of press time, CLO issuance has run north of $98 billion (36% higher than full-year 2016) and is now in ear-shot of 2014’s record $124 billion.

But CLOs aside, October’s performance was not all technically driven as the retail (+0.7%) and telecom (+1%) sectors rallied following two months in the red.  Even still, the retail sector, which represents 5% of index outstanding, continued to be the only major sector drag on the broader market this year.  While retail loans have totaled a negative 2.1% return through October, the slightly larger telecom sector has underperformed the broader market at positive 2.5%. 

So what does all this mean for 2017? Year-to-date, loan returns now total 3.6% - a level that trails high-yield (+7.5%) and high-grade bonds (+5.7%), but stands ahead of 10-year Treasuries (+2.1%).  On an annualized basis, loan returns come in at 4.32%, roughly 50 basis points below the LLI’s current weighted average nominal spread of L+345.   This is bit softer than most managers were expecting.   

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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