April 8, 2021 - The price rally in the secondary market finally took a breather in March after recovering for the better part of the past 11 months. But in retrospect, the rally has been weakening for months, culminating in March’s flat total return on the S&P/LSTA Leveraged Loan Index (LLI). Prices in the secondary fell 20 basis points in March, to an average bid level of 97.5, which led to the first market value loss (0.34%) reported on the LLI since last October. In looking back over the first quarter, the market’s monthly advancer/decliner ratio has illustrated a far less bullish trend than we witnessed at the tail-end of 2020. The ratio averaged better than 14:1 across November and December of last year, but during January, the ratio fell to a still bullish 8.4:1 before dropping to 2.4:1 in February. In March, the ratio finally reversed course where 71% of prices declined while just 20% advanced – which led to an advancer/decliner ratio of 0.3:1. In other words, for every loan price that advanced more than three declined. But mark-to-market price losses were not very meaningful in March, with 71% of total price movements totaling negative 1% or less. Interestingly, the high-beta side of the secondary continued to outperform in March where CCC rated loans returned 0.89% as compared to the negative returns produced by single-B and double-B rated loans, at (0.03%) and (0.27%) respectively. The contrast in performance was even more telling across first and second lien loans, where second liens returned 1.45% while first liens returned a negative 0.04%. But even after reporting a flat return in March, the LLI has generated a 1.8% return across the first quarter – a level that is firmly outpacing the bond markets (10-year treasuries, IG and HY included). From a bid level perspective, the secondary has tacked on an additional 135 basis point price gain so far in 2021, where bid-ask spreads have tightened an additional 34 basis points, to an average spread of 88 basis points.
While the hunt for yield continued to drive the riskiest of asset prices higher, credit metrics continued to strengthen, perhaps at a faster rate than most market participants were expecting. First off, the trailing 12-month default rate (by amount) fell another 10 bps in March: to a seven-month low of 3.15%; after hitting a post-pandemic high of 4.2% last September. Second, the three-month trailing downgrade-to-upgrade ratio has remained below a reading of 1 since February (signifying that there were less downgrades than upgrades). Lastly, Fitch noted that its “Top Market Concern Loans” list totaled just $38.6B (42 issuers) in March, down from $40B (44 issuers) last month and well off the $69.4 billion April 2020 peak (79 issuers). That said, March’s slight pullback in the secondary had much to do with technicals finally approaching equilibrium. On the supply side, the par amount outstanding tracked by the LLI expanded by almost $21B in March, more than triple the amount across all last year. As a result, the total par amount outstanding of the Index has increased $5.4B this year, to a new record, at $1.2T (prior to March, the LLI had contracted $16.4 billion across January and February). On the demand side, visible flows into the asset class continued to impress. The 2021 CLO market has already produced a record 81 deals, totaling more than $39B. In March alone, 31 CLOs priced, totaling $14.7B. At the same time, after two years of negative flows, loan mutual funds and ETFs are back in vogue. Inflows have now totaled more than $13B this year, after averaging north of $4B per month. Quite the change from 2019 and 2020, where redemptions totaled a staggering $47B.