March 8, 2021 - Loan prices in the secondary continued to tack on gains in February after staging an impressive rally across November through January, where bid levels surged by more than 420 bps (to an average of 97.35).  Most notably, after tacking on an additional 40 basis points in February, the market’s average bid level of 97.75 surpassed its previous high of 97.35 established last January.  At the same time, bid-ask spreads contracted another 15 bps to an average of 92 bps – the market’s first sub-100 reading since the summer of 2019.  While the current four-month rally has been impressive, market breadth has been on the decline. One of the more compelling storylines of the past four months has been the extremely bullish market sentiment that has supported the rapid rise in secondary levels.  Across November and December, the market’s monthly advancer/decliner ratio averaged better than 14:1.  During January though, the ratio fell to a still bullish 8.4:1 before dropping to just 2.4:1 in February, where 63% of loan prices advanced and 26% declined.  Even still, the S&P/LSTA Leveraged Loan Index (LLI) returned 0.6% in February; increasing its year-to-date returns to 1.8% – a level that is currently outpacing equity and bond market (IG and HY) returns. 

Interestingly, the high-beta side of the secondary continued to outperform in February where CCCs returned 1.9% as compared to the 0.52% and 0.29% returns produced by single-B and double-B rated loans, respectively.  While the hunt for yield clearly drove the riskier end of the market higher, credit metrics have, in fact, been improving.  First off, the trailing 12-month default rate (by amount) fell another 15 bps in February: to a six-month low of 3.25% after hitting a post-pandemic high of 4.2% in September.  Second, the three-month trailing downgrade-to-upgrade ratio fell below 1 (signifying that there were less downgrades than upgrades) after topping out at a ratio of 43:1 last May.  Additionally, Fitch noted that its “Loans of Concern” volume has dropped for 10 consecutive months and is at the lowest level since July 2019.  While traders bid up the lower end of the secondary, the market’s ongoing supply deficit hit a fevered pitch in February and led to another sizable increase in par-plus secondary activity where the percentage of loans priced above par increased to 28% (after reporting a 12-percentage point surge in January).  Market technicals continued to dictate the trend as the market priced $12.6B in new CLOs (after registering their best January, $8.2B, in eight years) while loan mutual funds & ETFs raked in an estimated $4.4B of inflows (after tallying their best monthly tally, $4.5B, in almost four years).  But this surge in visible demand once again hit head-on with yet another reduction in LLI outstanding where the volume of paydowns exceeded that of low-yielding new money loans.  And as we noted last month – combine that with a massive uptick in repricing activity, it is safe to say that the search for yield in the primary and secondary loan markets has become ever more daunting. To that point, the four-month rally in secondary loan prices reduced the discounted spread-to-maturity of LLI loans to L+407, the lowest reading since June 2019, according to S&P Global.  Furthermore, the LLI yield-to-maturity contracted to 4.3%, just 8 basis points away from the all-time low of 4.25% in March 2004.

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