November 5, 2020 - As we witnessed in September, the secondary loan market produced a strong start to the month in October as bids ran higher and year-to-date loan returns moved back into the black. But once again, the market couldn’t hold onto the gains through month-end as investor focus shifted back to COVID-19 and the election. The result? Although returns on the S&P/LSTA Leveraged Loan Index (LLI) remained positive in October, at 0.2%, it was the weakest performance recorded during the seven-month recovery that began in April. Following October’s uneven performance, YTD loan returns total -0.44%. With HY bond returns finally moving back to the black in October at 0.47%, this leaves the loan market as the only major credit asset class still sporting a negative return on the year. We note that, interestingly, the late-month selloff in the secondary loan market was more severe in the double-B rated space, where total returns ran slightly negative (-0.04%) as compared to the 0.27% positive return generated by single-B rated loans. While one would expect lower rated credits to underperform during selloffs, single-B loans have actually outperformed over the LTM period – returning over 3% since last November, compared to the -0.3% return for double-B loans.
October marked the first time during the seven-month rally where market value returns ran negative across the loan market, albeit slightly at -0.17%. Here too, we see that the market’s advancer/decliner ratio fell below 1:1 for the first time since March. In October, 51% of loans reported losses (a seven-month high) while just 40% of loans reported gains (a seven-month low). All told, average bid levels fell 5 bps to 93.13 across October after hitting an intra-month high of 93.74 on the 14th. Bid-ask spreads though, continued to tighten meaningfully as 13 bps were shaved from their average, which ended October at 144bps. Pre-selloff, the market’s average bid-ask spread toggled between a low of 110 bps in January to a high of 130 bps in late February. On the year, bid levels are still down 358 bps, or 3.7% while bid-ask spreads are wider by 29 bps or 25%. While multiple trends suggest the loan market rally might have stalled, or at least taken a breather, there are several positives to point to over the past two months. First, visible flows into the asset class are strengthening as primary lending activity picks up. For the second month running, CLO issuance topped $10B, driving the two-month total above the aggregate amount reported from May through August. At the same time, loan fund outflows fell below $2B across September and October, the lowest two-month total since the start of the year. Second, while credit trends haven’t meaningfully improved, at least they have not worsened. In October, the default rate by amount (and count) actually fell slightly, but remain elevated at 4.1% and 4.5% respectively. And as important, the 3-month trailing upgrade to downgrade ratio improved for the fifth month running – ending October at a 28-month low of 1.8 to 1. Seems like a breather.