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MTM Monthly October: Loans Take Over Pole Position

November 8, 2018 - With interest rates on the rise – the 10-year yield spiked briefly above 3.25% for the first time since 2011, inciting one of the most severe sell-offs in recent memory.  Heightened volatility also battered the fixed income markets, which all reported in red ink.  And that group unfortunately included the loan market, which saw its 14-month long streak of positive returns come to an end.  But there’s a caveat, S&P/LSTA Leveraged Loan Index (LLI) returns were barely negative, at -0.03%, while high grade and high yield bonds lost 1.33% and 1.6%, respectively.   October’s pullback further cemented the loan market’s eminence this year as loan returns (+4%) not only top those of the fixed income markets, they have now surpassed equities as well (+3%).

While October wasn’t bad on a comparative basis in loan land, mark-to-market (MTM) losses were widespread across the secondary with more than 11% of loans reporting price declines of 1% or worse.  All told, 76% of loan prices declined in October while just 13% advanced – a complete reversal from last month when the market reported a bullish advancer/decliner ratio of 3.25:1.  In turn, bid levels in the secondary fell by almost 50 basis points, with most of that weakness occurring during the tail-end of the month as the rout in fixed income intensified.  Hardest hit during the October swoon were loans priced above par. Their market share fell 20 percentage points to just 36% -  16 percentage points better than this year’s low (June) but 33 percentage points off this year’s high (January).  When the October dust settled, the LLI’s average bid level stood at 98.2, roughly 60 basis points below its early February high.  And as prices softened, the average MTM bid-ask spread widened six basis points to a four-month high of 77 basis points.

In looking back across the past year, the performance of the loan market has been closely tied to technical conditions as fundamentals have remained largely supportive. So it shouldn’t surprise readers that the loan market experienced its worst sell-off since summer 2017 while reporting its largest supply surplus ($16.5 billion) in 16 months.  On the supply side, the par amount outstanding tracked by the LLI grew by more than $25 billion in October, to a record $1.1 trillion. According to LCD, this was the second-largest growth month in 2018, behind the $28.2 billion increase in August.   But unfortunately, visible new demand levels (CLO issuance and loan fund flows) hit a nine-month low at the most inopportune time.  CLO issuance slowed to just $9.1 billion in October, roughly $2 billion lower than its monthly average this year. (This is due in part to AAA spreads increasing more than 20 basis points since hitting a 2018 low of 98 basis points in March).  At the same time, loan mutual funds reported 2018’s first monthly outflow at an estimated $600 million as investors sold into the weakness during the last week of the month, according to Refinitiv.  That said, at $15 billion so far this year, loan mutual fund inflows have illustrated a very different take on investor sentiment than the $25 billion in high yield bond fund outflows would suggest.    

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

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