August 6, 2020 - Loan prices in the secondary market continued to recover in July alongside other risk assets as volatility subsided. The broader markets have now rallied for four consecutive months after falling precipitously in March. In loan land, returns have softened since the height of the rally in April, when the S&P/LSTA Leveraged Loan Index (LLI) returned 4.5%. Even still, loans returned 11.9% since the end of March after tallying a 2% July return. YTD, loans remain in the red at -2.7%, a level that trails equities (+2.4%), and high-yield bonds (-0.2%). At the same time, safer assets, such as 10-year treasuries (14%) and high-grade bonds (8.2%), have – to no surprise – outperformed through the first seven months of 2020.
After improving 680 basis points (during April through June), the loan market’s average bid level rallied more slowly, adding 176 basis points in July. (Bid levels broke the psychologically important 90 bid barrier briefly in June before pulling back during the last week of the month).
By July’s end, average bid levels rallied to 91.6; five-plus points lower than their mid-January 2020 high-water mark. Strong market breadth drove performance in July as the market’s advancer/decliner ratio improved to 6:1, with 79% of loan prices advancing and just 13% declining. (July’s figures were a vast improvement over June when the ratio fell below 2:1.) Managers noted that a combination of low new issuance (June was busy relatively speaking) and robust CLO creation ($8 billion for the second month in a row) led to a strong bid across the secondary. And as bids continued to run higher in July, bid-ask spreads tightened another 30 basis points to an average of 186 basis points. This is the first sub-190 reading since the first week of March; spreads had previously gapped out to 400 basis points at the end of the first quarter.
The percentage of loans bid above 90 increased four percentage points in July to 72% as compared to the 62% figure reported in May, and just 26% in March. At the same time, the portion of the market bid sub-70 fell one percentage point to just 8%, from 12% in May and 14% at the end of the first quarter. But despite the lower end of the market showing resilience over the last two months, credit trends remained bearish as the market continued to experience an accelerated default cycle – the default rate swelled to 3.9% by amount and 4.1% by count in July, according to the LLI. Pre-COVID-19, those rates sat at just 1.6% and 1.5%, respectively. On a much brighter note, while downgrades continue to pressure funds and CLOs alike, the three month-trailing downgrade-to-upgrade ratio fell to just 7.9:1 in July. Last month the ratio was reported at 18.4:1 after topping out at a whopping 43:1 in March. That said, the 12-month-trailing ratio rose above 9:1 – more than three times higher than one year ago.