March 13, 2018 - With two weeks already on the books in March, the secondary loan market has regained its footing over the past five trading sessions. The average bid level on S&P/LSTA Leveraged Loan Index (LLI) rebounded above 98.5 this week, after falling during three straight sessions to begin the month. At its current bid level of 98.52, the secondary is now trading 20 basis points shy of its 2018 high water mark reached during the first week of February. But we all know how that ended. February loan performance came in at a three month worst as secondary prices fell 15 basis points. In turn, LLI returns totaled just 0.2% after tallying 0.96% in January. February’s meager return though was not all too bad considering loans grossly outperformed the other fixed income markets, including High-Yield (-0.93%) and High-Grade (-1.5%) bonds, which all ran ahead of the 3.7% fall in equities. Year-to-date, loan returns (1.16%) trail only equities, by roughly 50 basis points, but are far richer than bond market returns, including 10-year treasuries, which are the worst performers on the year at -3.65%.
Back to loans, where February market breadth was decisively bearish as 63% of loan prices declined and just 21% advanced. In other words, for every one loan price that advanced, three declined. Hardest hit were loans trading at a premium to par. Within this price segment, 68% of loan prices declined while just 15% advanced. Here we illustrate that for every one loan price that advanced, almost five declined. All told, par-plus loans fell by an average of 10 basis points while their market share dropped from a four-year high 70% in January to “just” 65% in February.
So what drove loan prices lower in February? From the looks of it, it was nothing to do with loans. First off, investors became increasingly anxious over equity valuations as the major stock indices flirted with record highs. Second, heightened concern over the rate of inflation and the repercussions it could have on interest rates and subsequent bond yields added to the hysteria (as of press time that fear has somewhat dissipated given the weakness in Tuesday’s U.S. inflation report). In loan land though, fundamentals remained supportive in February as new deal flow (less repayments) hit an 8-month high. All told, S&P/LSTA Leveraged Loan Index outstandings increased by more than $15 billion to a fresh record $980 billion. But demand levels came in even more robust, albeit slightly. CLO issuance more than doubled in February to $15 billion while loan mutual fund inflows hit $970 million. So from a technical perspective, new visible demand should have been more than adequate to handle the onslaught of new money loans. That said, supply levels have actually outpaced visible demand levels so far in 2018 by $3 billion ($25.4 billion compared to $22.2 billion, according to S&P LCD). And without the excess demand “crutch” which the market has enjoyed for quite some time, loan prices might have become susceptible to those aforementioned extraneous concerns about the broader markets – a trend that could continue in the months ahead.