January 8, 2020 - All is well that ended well in the fourth quarter. Following its worst monthly print this year (-0.45% in October) the S&P/LSTA Leveraged Loan Index (LLI) produced a risk-on driven 0.6% November return and an eight-month best 1.1% return in December. All told, fourth quarter LLI returns totaled 1.73%, and a three-year best 8.64% across full year 2019. Better still, the LLI 100, which holds the market’s 100 largest and most widely held terms loans, returned 10.65% on the year.
But it’s not as if it was a smooth ride from start to finish, actually far from it. The loan market began the year with a broad based recovery in the secondary during January and February where prices rallied an impressive 324 basis points (3.4%) off fourth quarter 2018’s oversold conditions. But the market pulled back in March when the Fed announced that rates would no longer be rising anytime soon. The weakness was short lived though, so we thought, as the rally continued through the first week of May. Then the headlines (and markets) turned their attention to the trade war following President Trump’s admission that the US would apply new tariffs on Chinese goods if a trade deal could not be reached (which it was not). The trade controversy and its implications for the global economy went on to set off a six month lull in the loan market where market value losses were reported during five of the next six months. As a result, total returns were limited to just 0.57% from May through October. But unlike the fourth quarter 2018 technically fueled sell-off where prices fell indiscriminately, a flight to quality trade dictated price action during most of the six month period. Managers, who became risk-adverse and skittish on credit, sold off lower quality names while bidding up the higher end of the market. By the end of October, the price action culminated in BB+ rated loans trading at a 580 basis point premium to B- rated loans – a level not witnessed in almost three years. In comparison, the differential stood at just 160 basis points at year-end.
Back to December performance in the secondary, where the market’s average bid level improved 115 basis points, ending the year at 96.72 or 288 basis points higher than it began. Importantly, the rally was broad based as December’s advancer/decliner ratio spiked to a 10-month high 5.8:1. In total, 76% of loan prices advanced while just 13% declined. Additionally, the lower end of the market continued to catch a bid in December and once again outperformed the higher rated cohort. Market value returns for Single-B rated loans totaled an 11-month high 1.43%, nearly triple the figure reported in the Double-B space. But despite their year-end push, single-B total returns (8.99%) still trailed double-B returns (9.31%) on the year. So what were the other noteworthy takeaways from 2019? On the technical front, new issue supply was mostly limited, with LLI outstandings rising by just $46.3 billion, or 4%, to $1.19 trillion. As for covenant terms, the fourth-quarter statistics generally moved tighter based on Covenant Review’s most recent analysis. On the demand side, CLO issuance remained strong at $118 billion, but was down 9% from last year’s record total. Most troublesome was the unrelenting outflows reported by loan mutual funds which totaled an estimated $38 billion across 2019. While December’s redemptions came in at a 14-month low of just $1.6 billion, outflows have been negative for 15 consecutive months for a grand total of $61 billion in lost capital. From a fundamental perspective, it was a mixed bag as well. Even though the default rate crept lower in 2019 to 1.39%, the percentage of loans rated B- increased their markets share to 14%, a rise of four percentage points across the year. But at the same time, CCC market share remained flat at just 6%. All-in-all, 2019 was a good year and 2020 has started fast and furious, with returns already totaling 0.32% after the first four trading sessions.