August 2, 2018 - Following two months of lackluster performance with returns averaging just 0.14%, the S&P/LSTA Leveraged Loan Index (LLI) returned a six-month best 0.74% in July. Better still: the LLI produced its first positive MV return (0.27%) since January as traders took advantage of oversold territory. Prices in the secondary market went on to rally 34 basis points in July, erasing all of June’s pullback and more. At 98.4, the LLI’s average bid level is still roughly 30 basis points off its 2018 high watermark established back in February. Even so, loans have returned 2.9% on the year and 4.4% over the last twelve months. Loan returns have topped each of the other major fixed income asset classes during both time periods, including 10 year Treasuries and High-Grade Bonds, both of which still find themselves in the red.
Back to July performance, where daily loan prices moved higher during 20 of 21trading sessions – no small feat! In turn, the market’s advancer/decliner ratio turned bullish for the first time since April. All told, 66% of loan prices advanced while just 21% declined. July’s ratio of better than 3:1 marked a six-month best and a full reversal from the previous two months when decliners outpaced advancers at nearly a 4:1 clip. Unsurprisingly, par-plus market share jumped 16 percentage points to 44%. While impressive, July’s total still represented the second lowest value reported this year. Finally, from a sector standpoint, Retail loans once again outperformed all other major industries in July by returning 0.91%. And at 5.3% on the year, retail comes in as the market’s best performer.
One of the more interesting story lines of July centered on loan market technicals. New supply once again outpaced demand for the third month running, albeit to a much lesser degree. On the demand side, CLO issuance slowed into the $10 billion context in July, down from a monthly average of roughly $11.5 billion in the first half. At the same time, loan mutual funds took in an estimated six-month low of just $650 million. And let us not forget LLI outstandings grew by a whopping $55 billion across the second quarter. But just as demand pulled back to start the third quarter, so did the new issue loan market. In total, the LLI reported a net increase of $16.1 billion in July which raised outstandings to $1.06 trillion. That left the market with a supply overhang of almost $6 billion, roughly in line with the previous two months. So why the recovery in July, you ask? First off, we know that demand is not restricted to just CLOs and loan mutual funds. And second, one sell-side trader noted that there’s billions of dollars in existing CLO warehouse lines out there at any given moment, and July might have represented the best buying opportunity of the year. Let’s hope he was right.
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