March 6, 2019 - Two months into the New Year, loan returns have totaled 4.2% – the best start to a year since 2009. After returning 2.6% in January, the S&P/LSTA Leveraged Loan Index (LLI) returned 1.6% in February as prices continued to rally in the secondary. And as S&P Global Market Intelligence noted, February’s stellar gains brought the Index Value back to where it was before the November/December sell-off. In the secondary market, average bid levels increased 118 basis points in February to 97.08, a three-month high. Since bottoming out in late December, prices have rallied 330 basis points. Furthermore, the market’s median bid level ended February at 98.75, marking a 275 basis point increase since year-end. The market’s advancer/decliner ratio remained bullish in February at 6.7:1, with 77% of loans reporting MTM gains and just 11% reporting MTM losses (last month those figures came in at 79% and 15%, respectively). And as prices continued to rally in the secondary, bid-ask spreads tightened another 10 basis points, to a three-month low of 105 basis points (after coming in by 25 basis points in January). But despite the storied rally, par-plus market share remained historically low; even after rising three percentage points it still sits at just 4%.
So what factors led to a second consecutive month of outsized gains in the loan market? First, loans were not alone in the rally. (Indeed, in 2019, they actually lagged equities and high-yield bonds, but outperformed high-grade bonds.) Clearly, the broader markets were oversold in December despite a supportive fundamental backdrop, particularly in loan land. Second, and closer to home, technicals have improved in the loan market at an increasing rate so far in 2019. In February, the primary new issue market was relatively subdued, while the pace of loan mutual fund outflows decreased and CLO issuance rebounded. On the supply side, LLI outstandings increased by just $11.4 billion in February after averaging a $20 billion increase during the previous two months. On the visible demand side, loan mutual fund outflows declined by roughly 30%, to an estimated $2.8 billion. Meanwhile, CLO issuance climbed north of $13 billion – or $2.4 billion more than the two previous months combined. In summary, while net new supply still outpaced visible demand ever so slightly, we must remember that CLOs and loan mutual funds represent a 63% market share of today’s total purchasing power. In turn, as those markets recover, it should be no surprise that prices in the secondary loan market continue to rise off of their oversold, technically induced year-end lows.