March 7, 2023 - Following a momentous start to the year across most asset classes, investors were aggressively “selling the rally” by the end of February. In loan land, secondary prices began to pull back from their recent highs in mid-February, ending a 56-day streak of positive returns in the Morningstar/LSTA Leveraged Loan Index (LLI). But unlike fixed income and equities, where returns ran negative, loans still produced a positive, coupon-driven 0.6% total return in February – despite reporting a nine-basis point market value loss. With just two months on the books, loans have already generated a 3.3% return in 2023, leading the bond markets (from HY bonds at 2.6% through 10-year treasuries at 0.3%) but trailing equities (the S&P 500) by less than 50 basis points.
Back to the February secondary loan market where market breadth was mostly flat after a decisively bullish January (where the advancer/decliner ratio hit 10:1). In February, the market’s advancer/decliner ratio dropped to 0.9:1, with 43% of loan prices advancing and 50% declining. In turn, the market’s average bid level decreased eight basis points, to 94.15, after rallying as high as 94.7 during the first two weeks of February. Even still, the month-end average bid reading remained above a 94 handle for just the second time since August. And as prices pulled back in late February, the market’s average bid-ask spread widened marginally, increasing three basis points to 116 basis points. February’s price action was most relevant in the 98 and above price cohort, whose share of loans slipped to 50%, from 54% in January. Within that price range, the percentage of loans priced at par and above fell below 3% after topping 4.5% the month prior. On the plus side, lower rated credits continued to outperform in February, particularly in the CCC range, where market value returns remained positive (unlike single and double Bs). In fact, CCC rated loans have already produced a total return in excess of 6% this year, as compared to double and Single B rated loans which have returned “just” 2.2% and 3.8%, respectively.
Away from the secondary market, LLI outstandings contracted by $6.6B in February, which marked the fifth consecutive monthly decline. The cumulative decrease in outstandings has now topped $34B or 2.4%. But while net new lending activity has remained a challenge this year, refinancing and A&E activity has surged, particularly in the single-B space, where borrowers have taken advantage of better market conditions to lower borrowing costs and/or to extend maturities. This brings two notes of good news. First, thanks to the increase in refinancing (and fallback amendments), JP Morgan reports that 30% of loans in their index are now SOFR based. Second, the maturity management efforts this year has led to a 6% reduction in the volume of loans coming due through the end of 2025, according to LCD. This is a welcome sign given that the default rate increased above 1% for the first time in 20 months during February; with the default rate now expected to rise into a 2% – 2.5% range by the end of year.