May 7, 2020 - Loan Prices Rally Off Oversold Territory in April

The secondary loan market continued to rally in April off the COVID-19 induced lows established during the third week of March. In a complete reversal from March where the S&P/LSTA Leveraged Loan Index (LLI) produced its second lowest monthly reading on record (-12.4%), the LLI gained 4.5% in April as mark-to-market (MTM) prices generally rebounded from oversold territory. We see this trend mostly in our advancer/decliner ratio which spiked to 4:1 in April, when 75% of loans reported MTM price gains and just 20% reported losses. It turns out the ratio was robust enough to lift the market’s average bid level by 326 basis points. By month-end, the average bid level climbed back to 86.1, almost 10 points higher than March’s low. Of course, this remains more than 11 points below 2020’s high water mark of 97.35 – established back in mid-January when working from home was a luxury, not a necessity. And as bids ran higher in April, MTM bid-ask spreads tightened by an average of 100 basis points from their near record March wides. That said, the market’s average bid-ask spread still sits north of 300 basis points, roughly three times wider than the pre-COVID 19 levels reported in January. From a price distribution standpoint, the “top-end” of today’s market (loans bid in a 92-98 context) best illustrated April price action. Here, the percentage of loans bid in that range increased 21 percentage points to a 47% market share (loans bid between 95-98 demonstrated the largest increase in market share, nearly tripling to 22%). That said, the 98 and above price cohort barely changed – rising from less than 1% to 2%. On the opposite end of the spectrum, select credits in beaten down sectors such as Energy and Lodging/Casinos rallied off their lows, returning 9.1% and 6%, respectively, in April). In turn, the percentage of loans bid below 80 decreased eight percentage points to a 17% market share. While certainly an improvement over March, the “stressed” side of the market remains triple the size it was in February. Clearly, credit trends are not our friend. In April alone, eleven LLI issuers defaulted, which raised the default rate by issuer count to 2.7%, the highest level since December 2010. Perhaps more problematic to any sustained recovery in secondary prices is the impact of recent rating actions linked to the shutdown of the economy.

According to S&P Global, “the ratio of downgrades to upgrades in the LLI accelerated at an eye-popping rate in April, from 3.8x on a rolling three-month basis in February, to 11.4x in March, and 22.1x as of April 30, the highest reading ever”. But on a much more positive note, the technical pressure on prices eased tremendously in April. While CLO issuance remained in a mid-$3 billion range, loan mutual fund outflows totaled just $3.4 billion – a far cry from the massive $14.7 billion in outflows reported in March. And at the same time, the primary loan market remained mostly closed in April while pay-downs decreased LLI outstandings by almost $8 billion. So one can argue that technicals improved April, but that thesis will be tested in May as more primary deals are likely to emerge.

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