June 9, 2021 - by Ted Basta. The secondary loan market continued to trade higher in May as the lower-end of the secondary once again outperformed. Following April’s 0.51% return, the S&P/LSTA Leveraged Loan Index (LLI) returned 0.58% in May. YTD loan returns continue to lead the fixed income markets at an impressive 2.9%, as loans broadened out their lead over high-yield bonds to 63 basis points (following HY’s weakest showing in eight months, at 0.26%). Unsurprisingly, both the loan and high-yield bond markets continue to outpace the high-grade bond and 10-year treasury markets, where YTD returns remain in negative territory at -2.7% and -5.5%, respectively. That said, these rate-sensitive and lower yielding asset classes have outperformed over the past two months, particularly in April where returns were north of 1%.
Back to the secondary loan market where bid levels increased 29 basis points in May, to an average of 98.1 – the market’s first reading above a 98-handle since November 2018. Today’s average bid level is 190 bps stronger on the year and 75 bps higher than last year’s pre-pandemic high-water mark established in January 2020. Even more telling as to how rich the secondary is trading this summer is the market’s median bid level, which rose above 99.5 reading. Furthermore, market breadth remained decisively bullish in May as the secondary’s advancer/decliner ratio was reported at better than 2:1 for the second month running. All told, 68% of loan prices advanced while just 21% declined. And as the secondary traded higher, the average bid-ask spread tightened another five basis points to 75 basis points – its lowest reading since late 2018. Additionally, the median bid-ask spread was reported at just 55 basis points.
Once again, the high-beta/yield-rich side of the secondary outperformed in May with CCC rated loans (9% of outstandings) returning 1.1%. Single-B (60% of outstandings) and double-B rated loans (20% of outstandings) produced lower returns, at 0.6% and 0.4% respectively. According to the LLI, the CCC sub-index has rallied for 14 consecutive months, gaining over 47% during this period after losing 22% during the March 2020 sell-off. But there is a natural trade-off of rising prices of course, lower yields. And this trend is evident within the single-B space, according to research by S&P Global. As prices on B-minus loans advanced this year, the discounted spread-to-maturity (STM), fell to just L+460 basis points, a post- Global Financial Crisis low. In addition, the gap between the discounted STM of B-minus and B-flat loans narrowed to just 51 bps, also the lowest post-crisis reading. In comparison, B-minus loans offered roughly a 150-bps premium over B-flat loans during the three years prior the onset of the COVID-19 pandemic. Risk aversion has clearly dissipated as investor demand for higher yielding paper has intensified alongside a meaningful strengthening in credit metrics. First, according to the LLI, the trailing 12-month default rate (by amount) fell another 88 bps in May, to a 17-month low of just 1.73%, after hitting a post-pandemic high of 4.2% during September. Second, the three-month trailing downgrade-to-upgrade ratio has remained below 1:1 since February (signifying that there were fewer downgrades than upgrades). Even more impressive, the three-month trailing ratio has been reported below 0.5 since April.
For more information on the secondary market, please contact Ted Basta.