LSTA Secondary Market Monthly: 2017 Executive Summary

January 11, 2018 - And that’s a wrap.  The S&P/LSTA Leveraged Loan Index (LLI) posted a 4.12% return in 2017 – slightly below the coupon-level return most were expecting.  All told, market-value (MV) losses on LLI loans totaled 0.69% during 2017.  This is a far cry from the outsized 4.8% MV gain of 2016 when total return topped 10% for just the third time since 1997.  But in hindsight, 50% of loans were trading 25 basis points above par in the secondary to begin the year – and that turned out to be a difficult level to maintain.  Not that there was that much downside pressure: Prices proved to be quite stable in 2017, with most loans trading within a very tight band.  All told, the average bid level on the LLI decreased one basis point to end the year at 98.05 after hitting its high water mark (98.62) back in March and its low in November (97.9).  While the average bid fluctuated (a bit), the median price has remained at or above par since September of 2016.  The result? A surge in repricing activity that swept up more than 50% of loans in the LLI.  

While all eyes were focused on 2017’s record refinancing activity (and the subsequent reduction in new issue spreads), it was a rise in rates that kept yield levels in the secondary unchanged over the last twelve months.  To that point, even though the weighted average spread on the LLI fell 55 basis points, 3 month LIBOR increased 56 basis points.  So thankfully that was a wash from an interest return perspective (at least for total return investors).  So what were the other noteworthy 2017 take-aways?  Let’s begin with credit, where, despite a recent up-tick in defaults (and six Chapter 11 filings in the fourth quarter), the current credit cycle remains intact.  According to S&P Global, the default rate by amount closed the year at a 17-month high of 2.05%, a steady climb from the August low of 1.36% – but still well inside the historical average of 3.1%.   In looking forward, credit issues are said to be concentrated in a handful of sectors – namely retail, broadcasting (iHeartMedia is expected to trigger a default on its $6.3 billion of Clear Channel loans in the near future) and possibly healthcare.   

Second on the list of takeaways were loan market technicals where demand surged above net new supply during 10 of the last 12 months.  In total, aggregate visible demand outpaced net new supply to the tune of $75 billion.  On the supply side, total par outstanding on the LLI grew by $66 billion – or 8% –to a record $960 billion. To put that in perspective, the 8% growth rate was more than 2015 (6%) and 2016 (1%) combined.  On the demand side, new CLO creation alone topped the rise in outstandings as CLO issuance came in at $117 billion – just $7 billion shy of 2014’s record.  Safe to say that figure blew past all estimates given the uncertainty that had surrounded the possible effects of Risk Retention.  Just as surprising though, was the tale of two halves for loan mutual fund flows.  Over the course of the first five months of 2017, loan funds raked in almost $20 billion in new money.  But during the next seven months, investors redeemed $5.5 billion which in turn reduced 2017’s full year total to just north of $14 billion.  (Of note, Nov.-Dec. outflows totaled $5.5 billion).   

But all’s well that ends well. And 2017 did in fact end on a high note which hopefully will set the tone for a profitable 2018.  December performance was quite good with the LLI registering a 0.4% return; this upped fourth quarter’s return to 1.11% - the best quarter since the first one of the year.    

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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