October 7, 2024 - The Federal Reserve cut interest rates in September for the first time this cycle, a watershed moment that had been anticipated for some time and a recalibration to monetary policy from fighting inflation to preserving economic growth. The impact of the Fed’s action to corporate credit was felt across the third quarter, when returns for U.S. high-yield bond bonds pulled ahead of broadly syndicated loans (BSL). Loans have been the beneficiary of higher interest rates because of their floating-rate structure, and they returned 2% in 3Q24, compared to HY bonds’ 5.28%, according to the Morningstar LSTA Leveraged Loan Index (LLI) and the Bloomberg U.S. High-Yield Corporate Bond Index. And while year-to-date BSL returns of 6.54% trail HY bonds’ 8%, looking back to March 2022, when the Fed started raising interest rates, BSL has outperformed and returned 20%, compared to 13% for HY bonds, while the S&P 500 rocketed ahead 31.75%.

Focusing on September, BSL returns improved to 0.71%, again entirely driven by interest income, as the market value component of return declined for the fourth consecutive month. So far this year, coupon clipping from BSL has rewarded investors 7.13%, offsetting 0.55% of market value losses in the LLI. In contrast to a volatile August that saw prices plunge 56 basis points in one day, the average price on the LLI ended September four basis points lower to 96.71. In fact, the LLI’s price level was unchanged in six out of 21 trading sessions in the month, with the daily price changes staying within two basis points for 18 trading sessions. The flat secondary helped narrow the average bid-ask spread to below pre-August levels at 84 basis points after spiking to over one point on August 5. The lack of volatility in the secondary market also led to the share of loans priced between 98 and par increasing to 46% – the highest since February. Meanwhile, the share of loans priced above par declined to 25%, the lowest since February.
In the primary market, while the return of repricing activity helped keep a lid on the par-plus share of the secondary market, August also saw an increase in non-refinancing activity, driven by a jump in dividend volume along with an uptick in M&A. This mix helped drive the non-refinancing share of institutional activity to the highest level since the Fed started hiking rates, according to Pitchbook LCD, making up 38% of the $128B of institutional loans pricing in September, double the average in the first half of the year.
On the demand side, the Fed’s pivot to lower interest rates continues to impact retail interest for floating-rate debt. Although outflows from loan mutual funds and ETFs ebbed to $240 million in September, according to LSEG Lipper it marked the second consecutive month of retail selling for a total $5.3 billion, compared to an average monthly inflow of $2 billion recorded between January and July this year.
Institutional demand from CLOs has been stickier and added $11.9B of new paper in September, most of which ($9.6B) represented BSL-focused CLOs. Although activity in the month declined to the second lowest monthly tally all year, at over $141B year-to-date, volume remains on track to eclipse 2021’s record.
Together, visible demand from CLOs and retail funds totaled $11.3 billion in September, marking the second lowest figure for the year. However, the institutional market shrunk for the third consecutive month, with outstandings on the LLI decreasing by $4.4 billion in the month and 1% for the year, as the uptick in new money was insufficient to offset repayments. A continuation of the trend this year as loan supply has not yet matched investor demand.