November Secondary: The Storm?

December 6, 2018 - November loan returns were in the red for the second time in as many months, a dubious feat last seen in early 2016.  But October proved to be the calm before the storm as S&P/LSTA Leveraged Loan Index (LLI) returns sank to -0.9% in November, after falling just 0.03% the prior month.  Indeed, November marked the worst monthly performance for the LLI since December 2015.  But of course, loans were not alone in the November sell-off as high-yield bond returns (-0.91%) matched their senior secured brethren while high-grade bonds reported a more modest loss of 0.19%.  At the same time, both equities (+2%) and the 10-year (+1.4%) produced late-month rallies after experiencing heavy losses in October and early November.  That all said,  November’s pullback didn’t change the narrative for the loan market much as year-to-date loan returns (+3.1%) continue to top those of the other fixed income markets (which remain negative on the year).

November mark-to-market (MTM) losses were widespread with almost 50% of loans reporting price declines of 1% or worse.  All told, 90% of loan prices declined while just 4% advanced – markedly worse results than the previous month when 76% of prices declined and 13% advanced.   In turn, bid levels in the secondary fell 136 basis points in November, after dropping 50 basis points in October.  At an average bid of 96.78 and a bid-ask spread approaching 100 basis points (up 26 basis points since September), the secondary is currently trading at levels last seen in late 2016.  Even more telling of the indiscriminate November sell-off, each of the top 23 LLI sectors (representing 1% or more of total outstandings) reported negative returns.  Unsurprisingly, as the price of crude oil plummeted, the Oil & Gas sector was the worst performer of the month at -1.9%, while Chemicals & Plastics and Food Products were the market “leaders” at -0.6%.   And as we saw last month, hardest hit during the November swoon were loans priced above par; their market share fell 31 percentage points to just 5%.

In looking back across the past several months, the performance of the loan market has been closely tied to technical conditions. So it shouldn’t be surprising that the market experienced its worst two-month sell-off in two years while reporting a rather large supply surplus (almost $19 billion) since September.  On the supply side, the par amount outstanding tracked by the LLI grew by more than $36 billion over the past two months, to $1.13 trillion. But visible new demand (CLO issuance and loan fund flows) totaled slightly more than $17 billion over the same period.  CLOs, though, were clearly not to blame given that issuance has averaged a healthy $11-plus billion since September. Instead, it was the retail side of the market that changed course, as fund outflows totaled $5 billion, with $4 billion occurring in November.

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