March 5, 2020 - Concerns over the coronavirus outbreak finally rattled the US capital markets during the last week of February. Last week’s plunge in equity prices was the worst since the financial crisis, with the S&P 500 down double digits. While China’s official manufacturing PMI plummeted to a record low 35.7 in February, the broader impact on the global economy is still uncertain. That said, Goldman Sachs reported that they now expect zero profit growth for S&P 500 companies in 2020. This week, the markets continued to trade in violent fashion but have rebounded during days which followed sell-offs. On Tuesday, the Federal Reserve cut interest rates by 50 basis points in an emergency move to help shield the US economy from the fallout (this signified the central bank’s first emergency rate cut since the height of the 2008 financial crisis). And by the close of trading on Tuesday, US treasury yields hit all-time lows with the benchmark 10-year rate dipping below 1% for the first time ever. Interestingly, equity markets finished severally lower on the day but rebounded on Wednesday as the Street cheered Joe Biden’s Super Tuesday results. Alas, the markets traded sharply lower on Thursday, following the massive relief rally in the previous session.
So how has the leveraged loan market reacted to the heightened volatility? Like equities and high yield, the last week of February was tough as there was an indiscriminant selloff across the secondary loan market. During the last five trading sessions of the month, the S&P/LSTA Leveraged Loan Index (LLI) returned -1.54%, the largest such decline since August 2011. Prices in the secondary would go on to fall 150 basis points last week, to 95.18 – more than two points lower than 2020’s high water mark established in late January. On a positive note, according to traders, liquidity held up well as trading volumes spiked while bid-ask spreads widened out by an average of 25 basis points. The late February price action led to a – 1.32% return across the month, slightly better than the high yield bond market’s -1.55% return and much higher than the S&P 500’s -8.23% return. That said, the loan market’s February decliner/advancer ratio was reported at 11:1, with 89% of loans reporting MTM losses. The high end of the market was hit hardest as the percentage of loans bid above par declined 31 percentage points to just 4%. The lion’s share of those loans now sit in the par to 98 bid range, which now totals a 53% market share (up from January’s 35% reading).
So far this week, through the first three March trading sessions, performance has been mixed in the secondary loan market as average bid levels hovered within a 25 basis point range between 95.16 to 94.91. As we look forward, a lot is yet unknown regarding how the spread of the virus will impact loan market issuers. But the severity of the impact, at least in the short term, might not be all that bad according to a recent research report by Fitch Ratings. The report concluded that a mix of diversification, leverage headroom, and liquidity buffers will help leveraged loan issuers absorb demand-side contractions because of decreased economic activity due to the virus.