February 4, 2021 - Loan prices in the secondary continued to strengthen in January after staging an impressive rally across November and December where bid levels surged by more than 300 bps (to an average just above 96). Most notably, after tacking on an additional 117 basis points since year-end, the market’s average bid level finally retraced its previous high of 97.35 established last January. At the same time, bid-ask spreads contracted another 14 bps to an average of 108 bps – right on top of their pre-pandemic levels. The V-shaped recovery in secondary prices is now complete, and then some. Holding the 97-bid level, though, has proven to be a daunting task over the past several years. While the market was firmly bid in a 97-range last January, it had only flirted with that level two other times over the past two years (in April and July of 2019).
One of the more compelling storylines of the past three months has been the extremely bullish market sentiment that has supported the rapid rise in secondary levels. Since month-end October, the market’s monthly advancer/decliner ratio has averaged 12:1, where 86% of loan prices have advanced with just 7% declining. And while the ratio did fall to 8.4:1 in January, the S&P/LSTA Leveraged Loan Index (LLI) still returned 1.2% – a level that outpaced equity and bond market (IG and HY) returns for just the second time across the past 10-month recovery period. Interestingly, the high-beta side of the secondary outperformed in January, where default-stricken sectors such as Leisure (2.6%), Oil & Gas (1.6%), Retail (1.4%) and Lodging/Casinos (1.4%) all outperformed the broader index. The same trend was found in rating segments, where CCCs returned 3% as compared to the 1.1% and 0.7% returns produced by single-B and double-B rated credits, respectively. While the hunt for yield drove the riskier end of the market higher, credit metrics may, in fact, be improving. First off, the default rate by amount fell 45 bps in January to a five-month low of 3.4% after hitting a 10-year high of 4.2% in September. Second, the three-month trailing downgrade-to-upgrade ratio fell to just 1.02:1 – a four-year best.
While traders bid up the lower end of the secondary, the market’s ongoing supply deficit (more on that later) hit a fevered pitch in January and led to a surge in par-plus secondary activity; the percentage of loans priced above par more than doubled to 21%. Market technicals were clearly at play here as CLOs registered their best January issuance figure ($8.2B) in eight years while loan mutual funds & ETFs raked in an estimated $4.5B of inflows – their best monthly tally in almost four years. But this surge in visible demand, particularly on the mutual fund/ETF front, hit head-on with an actual reduction in LLI outstanding as the volume of paydowns exceeded that of the low-yielding new money loans that came to market in January. Combine that with a massive uptick in repricing activity, and it is safe to say that the search for yield in the primary and secondary loan markets – indeed, in all markets – has become ever more daunting.