November 7, 2019 - For the second time in three months, loan returns were negative in the loan market.   After returning 0.47% in September, the S&P/LSTA Leveraged Loan Index (LLI) produced a 0.43% loss in October –the worst monthly print this year.  Market value losses within the index were steep in October, at 0.94%, which represented the fifth time in the past six months (and third month in a row) where market values were negative.  All told, the average bid level fell 92 basis points to a 95.4 handle, the first sub-96 reading since early January.   At the same time, the average bid-ask spread expanded 10 basis points to an eight-month high of 114 basis points. 

Losses were widespread across the secondary as 75% of loans reported mark-to-market price declines while just 16% registered gains.  In other words, for every one loan price that advanced, 4.7 declined.  October’s indiscriminant pull-back left no rock unturned as each of the largest 10 sectors of the market reported negative returns. Telecom and leisure suffered the worst losses, at -0.9% apiece.  Even the “Teflon Dons” in the double-B space reported a negative return in October, albeit at just -0.02% (but market value losses totaled 0.43%).  In comparison, single-B names pulled off their worst return on the year at -0.69% as loans rated B- lost 1.05%.  Safe to say the flight to safety trade was still active, particularly given October’s slew of downgrades which sent the rolling three-month downgrade ratio to a post-recession high of 5:1, according to LCD.   Unsurprisingly, a noteworthy percentage of price movements across the market were significant to the downside with 34% of loans reporting losses of 1% or more while 6% of loans registered losses of 5%-plus.  Such price action led to an upsurge in the sub-90 segment of the market, which increased to a 15% market share from 11% in September.  Conversely, the percentage of loans priced above 100 fell to 16% from 24%.   But there is a silver lining for loans: they appear to be oversold now while their high-yield brethren in the bond market seem overbought.  According to research by Marty Fridson at Lehmann Livian Fridson Advisors, the difference between the three-year discounted spread on the LLI and the option-adjusted spread (OAS) on the ICE BofAML US High Yield Index reveals that bonds are extremely rich versus loans.  His analysis hadn’t reached that conclusion since early 2017.  And that view was shared by CITI in a recent research piece which discussed why loan-high yield relative value continues to veer in loans’ favor.  Their conclusion: loan yields look attractive versus high-yield, a message that could resonate with cross over investors and lead to an influx of new liquidity in the secondary loan market. 

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