February 10, 2025 - The new year brought a change to Washington with the inauguration of a new president intent on disrupting business as usual and investors attuned to the accompanying risk and opportunity. But in the loan market, however, it was more of the same: a technical imbalance with new loan supply falling short of high demand from investors, another wave of opportunistic repricings, and a highly bid secondary market with returns propelled by high interest rates.
Starting with returns, broadly syndicated loans (BSL) benefited from investors’ appetite for risk and returned 0.69% in January, per the Morningstar LSTA Leveraged Loan Index (LLI). Performance was in line with returns from a year earlier and slightly lower compared to average monthly returns over the last 12 months (0.72%). Interest income again accounted for the lion’s share of return with SOFR remaining at historically high levels despite 100 basis points of interest rate cuts from the Fed. In addition to coupon clipping, secondary prices continued to inch higher and ended January 29 basis points higher at 97.62, the highest level since April 2022, enough to swing the LLI to a positive market value return (0.01%). Like at the end of last year, the share of the secondary market priced above par remained above 50% in January, leading to another wave of repricings and reports of “thrice” repriced loans that are estimated to shave an additional 5 basis points of spread from the market, on top of the 28 basis points shaved over the course of last year, according to Citi.
The risk-on trade across markets also sent returns on the riskiest loans higher. Loans rated CCC returned 0.96% in January, while total return for B and BB rated loans was nearly identical (0.67% and 0.66%, respectively). Notably, average prices for CCC loans advanced for the first time in four months (up 111 basis points to 82.4).
From the demand side, inflows into loan mutual fund & ETFs jumped to $4.9 billion in January, the largest inflow since April 2022, according to LSEG Lipper, as investors bet on a higher-for- longer rate environment. CLOs had a slower start to the year after an unusually strong December that capped off a record year. The first new issue didn’t price until mid-month, with January adding $8.7 billion of new issue, spread over 17 deals, compared to a monthly average of $16.7 billion last year. Despite the lowest issuance since December 2023, investor demand remained strong and spreads tightened across the stack: Average spreads on BSL AAA ended the month 7 basis points lower at 124 basis points, the tightest since the market transitioned to SOFR, with demand extending to CLO mezzanine bonds, narrowing the spread between AAA and BB tranches to a record ~337 basis points.
Ever tighter spreads continued to spur reset and refinancing activity in the new year with $17.9B in resets and $12.7B of refinancings, per Citi Research.
While visible demand from new issue CLOs and inflows to loan mutual funds added up to $13.6 billion in January, the institutional market shrank for the first time in four months. Using LLI outstandings as a proxy, the institutional market decreased by $6 billion to $1.41 trillion with repayments driven by refinancings making up most of the activity. But relief may be forthcoming. Overshadowed by yet another new record month for repricings, non-refinancing activity increased to $35 billion in January, per Pitchbook LCD, well above levels observed over the last three years, as an M&A pipeline begins to take shape.
Fundamentals remain in check. Competition for assets from private corporate credit lenders in part helped lower the CCC share of the market (5.1% of the LLI vs 6.7% a year ago), with the median CLO exposure to CCC loan collateral at 4.9%, the lowest level since early 2023, according to Deutsche Bank analysis. The conventional default rate remains low (1.5% by count) but increases to 4.58% when including liability management transactions (LMTs), according to the LLI. Fitch Ratings is forecasting a decline in the default rate to between 3.5% and 4% in 2025, as deals roll off the trailing 12-month period.
In other asset classes, equities bounced back from a setback in December and the S&P 500 returned 2.78% in January, while U.S. high-yield bonds advanced 1.37%, according to the Bloomberg U.S. Corporate High Yield Index. Still, 2025 may prove volatile. Markets generally stalled in the last week of the month on news from China of a cheaper AI model and hit turbulence again at the beginning of February following tariff threats from the new administration that could lead to a run up in inflation.
