May 5, 2023 - Markets shrugged off the previous month’s volatility stemming from several bank failures to deliver positive returns in April. At 1.1%, April loan returns were the highest since January, when average bid levels jumped 178 basis points, according to the Morningstar/LSTA Leveraged Loan Index (LLI). In comparison, loan prices staged a mini-rally in April, with average bid levels improving 29 basis points to 93.7. Better still, bids were 111 basis points higher than their March 20th lows, when Swiss authorities arranged for the rescue of Credit Suisse by rival UBS. But, in actuality, the secondary remained choppy, with loan bids advancing during 18 of the next 29 trading sessions (62%) through the end of April. In the meantime, US high-yield bonds returned 1% in April; I-grade bonds and Treasuries lagged at 0.9% and 0.5%, respectively, according to Bloomberg Indices. For the year through April, loan returns stand at 4.3%, mostly driven by an outsized 2.7% return in January, the highest since May 2020. That said, loan returns have slightly underperformed the rest of fixed income YTD.
Back to the April secondary loan market, where market breadth turned bullish with two-thirds of names advancing and 27% registering mark-to-market losses. This was a complete reversal from the previous month when 65% of loans declined and 29% advanced. In April, 51% of loans registered modest increases in bid levels (gains of 1% or less), while 19% of loans were higher by 1% to 5%. Correspondingly, the average bid-ask spread tightened 9 basis points to end April at 118 basis points, after widening to a recent high of 135 basis points on March 20. April loan returns were driven by the first market value gains since January (0.31%), with interest income contributing 0.74% to total return. Meanwhile, 2.9% (of the 4.3%) YTD total return has come from reference rates, as 1-month Libor and term Sofr increased to 5.3% and 5%, respectively, from around 1% a year ago. In contrast to last year, when fears of a recession led to a deep sell-off in lower rated loans, the lower rungs of the credit scale have outperformed so far in 2023. April marked the third time this year that CCC rated loans advanced, after posting a 1.5% return in April, which drove YTD returns to 5.5%.
Turning to market technicals, following size months of declines (reducing LLI outstandings by $32 billion), outstandings registered a modest increase of $1.1B in April. On the demand side, despite tighter new issue spreads this year, CLO issuance declined to just $7.6B in April; this marked the lowest level since January, as arbitrage was a concern for equity investors. Outflows from loan mutual funds and ETFs ebbed to $2.2B in April, after hitting $5.7B during the market turmoil of April, according to Lipper. In turn, net visible demand of $5.4B outpaced meager new loan supply for an eight straight month. The Fed delivered its tenth interest rate hike this cycle on May 3, but signaled that there could be a pause ahead. But higher rates have already been pressuring interest coverage ratios across the market as Fitch’s default rate has increased to 2.2%, with forecasts calling for default rates to increase into a 3-4% range in 2024