December 11, 2019 - Last month in this space we boldly wrote “there is a silver lining for loans: they appear to be oversold”. And sure enough, following its worst monthly print this year (-0.45% in October) the S&P/LSTA Leveraged Loan Index (LLI) produced a four-month best 0.6% November return. Better still; the LLI has already tacked on an additional 0.63% during the first seven trading sessions of December as the “rally” continues to gain steam into year end. All in, the LLI has delivered a 7.6% return so far in 2019- a three-year best.
Back to November performance in the secondary, where the market’s average bid level improved for the first time since July. While prices rose by a modest 13 basis points, there were several positive trends to point out. First, the advancer/decliner ratio, which was reported at 1.6:1, illustrated stronger investor sentiment as 54% of loan prices advanced while 33% declined. Furthermore, 19% of loans reported MTM gains of better than 1% – a seven-month high. Second, the lower end of the market finally caught a bid in November and outperformed for the first time in four months. Market value returns for Single-B rated loans totaled 0.36%, triple the figure reported in the Double-B space. Even more impressive, the B- rated segment of the market reported a market value increase of 0.4%. But despite the gains in November, B- rated loans remain the only rating category where market values are in the red on the year. The cohort is currently trading, on average, at a 580 basis point discount to par. Clearly, trading decisions in this space will make or break returns in 2020, particularly given that it represents a 13.5% share of outstandings (four percentage points higher than last December’s reading). Third, while loan mutual funds continued to report outflows for the 14th month running, November’s figure of $1.9 billion represented the lowest in 13 months and a 44% reduction over 2019’s average monthly withdrawal of $3.4B.
On the downside, outsized MTM losses remained relatively high in November with 5% of loans reporting price declines of 5% or worse. On the industry front, the oil and gas industry continued to underperform. Wide spread downgrades and several defaults continue to plague the beleaguered industry. This meant that the sector once again led all laggards by returning -2.8% in November. Moreover, this was the 7th consecutive month of negative returns in the sector, where year to date returns sit at -6.25%.And the pain is expected to continue into 2020 according to Fitch Ratings, who forecast Energy defaults to rise to 13% next year, an eight percentage point increase over this year’s default rate. Luckily, this struggling segment of the market represents just 3.4% of LLI outstandings. On a positive note, the Electronics industry, which is the largest sector at a 15% market share, has returned 8.7% this year.