Senior Loan Talking Points – June 4, 2020

Jeffrey Bakalar
Dan Norman
  • Steadily improving macro conditions led to another round of strong gains in global financial markets, loans included. The S&P/LSTA Leveraged Loan Index (the “Index”) returned 1.43% for the weekly period ended June 4, while the average Index bid now sits above the 90 mark for the first time since early March, aided by a 124 basis points (“bps”) improvement in this week’s trading session.
  • Similar to the prior few weeks, the rally was led by lower-rated loans, with the CCC bucket being the outstanding performer during this period. A heavy portion of the price action was driven by the most at-risk COVID-19 sectors, which have rebounded significantly from the March troughs.
  • Despite the stronger secondary trading levels, primary market activity remained in low gear this week, as just $1.1 billion was launched into syndication, nearly matching the $1.2 billion from the previous week. In the forward pipeline, repayments continue to outpace new supply by about $7.9 billion this week (net of expected repayments).
  • Two more CLOs were issued this week, bringing YTD totals to $27.6 billion. For the five business days ended June 3, outflows totaled roughly $207 million for loan mutual funds and ETFs.
  • There were two defaults in the Index during the week. These include California Pizza Kitchen within Restaurants and Libbey Glass within the Home Furnishing sector. The default rate by amount outstanding currently stands at 2.81%.
Average Bid
Average Three Year Call Secondary Spreads
Lagging 12 Month Default Rate
Index Stats

Source:  S&P/LCD, S&P/LSTA Leveraged Loan Index and S&P Global Market Intelligence. Additional footnotes and disclosures on back page. Past performance is no guarantee of future results.   Investors cannot invest directly in the Index.

The U.S. loan market continued its rally in May along with other risk asset classes. Stronger secondary trading was propelled by growing investor confidence in the U.S. economy reopening. In turn, the Index gained a robust 3.80% in May, following a 4.50% advance in April.  After gaining 236 bps last month, the Index’s average bid level moved up another 292 bps in May and ended the month at 89.06, the highest level since March 11.

In particular, the healthier sentiment boosted performance among some of the sectors that were impacted the hardest by the imposed lockdown restrictions and subsequent shuttering of business activity during the apex of the virus pandemic. These sectors would include retail, restaurants, lodging/casinos, and anything leisure or travel-related. Other top performers were those in the energy space, as the sector was buoyed by stronger commodity prices and increased demand for oil. Further illustrating the risk-on move, lower-rated loans outperformed their higher-rated counterparts in May, following a trend that began to take root in April. CCCs and single-Bs, returned 5.26% and 4.60%, respectively, while BB-rated loans lagged behind at 2.67%. Given how sharply loan bids fell within lower-quality cohorts during March’s sell-off, BBs still remain ahead in the YTD leaderboard, though the gap is closing quickly, as single-Bs have benefited the most amidst the recent price recovery.

Turning to the technical equation, loan supply was behind April’s pace and remains somewhat under pressure, as evidenced by a light new-issue forward calendar. Included in this month’s volume was a handful of M&A transactions, while the rest of the deal flow backed opportunistic financings. On the demand side, CLO origination saw an uptick with roughly $6 billion printed in May. However, these deals were either static or included one to three-year reinvestment periods, versus the typical four to five-year reinvestment period included in most vehicles prior to the pandemic. A material increase in CLO supply is not expected to commence until AAA liability spreads tighten considerably. At the same time, U.S. retail loan investors withdrew $1.8 billion from the asset class, which is down notably from the prior two monthly totals.

Elevated default activity continued in May with another eight Index constituents tripping defaults, pushing the Index default rate to 3.14% by amount outstanding. This spike breached the historical default rate of 2.85% for the first time in more than five years. Given the current environment, most market participants expected this to happen sooner rather than later, as the early impact and initial analysis of the virus painted a challenging picture. In contrast, downgrade action by ratings agencies slowed in May to 90 loan downgrades, compared to a record 228 in April and 114 in March.

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Unless otherwise noted, the source for all data in this report is Standard & Poor’s/LCD. S&P/LCD does not make any representations or warranties as to the completeness, accuracy or sufficiency of the data in this report.

1 – Assumes 3 Year Maturity. Three year maturity assumption: (i) all loans pay off at par in 3 years, (ii) discount from par is amortized evenly over the 3 years as additional spread, and (iii) no other principal payments during the 3 years. Discounted spread is calculated based upon the current bid price, not on par. Please note that Index yield data is only available on a lagging basis, thus the data demonstrated is as of May 29, 2020.

2 – Excludes facilities that are currently in default.

3 – Comprises all loans, including those not tracked in the LPC mark-to-market service. Vast majority are institutional tranches. Issuer default rate is calculated as the number of defaults over the last twelve months divided by the number of issuers in the Index at the beginning of the twelve-month period. Principal default rate is calculated as the amount defaulted over the last twelve months divided by the amount outstanding at the beginning of the twelvemonth period.

General Risks for Floating Rate Senior Loans: Floating rate senior loans involve certain risks. Below investment grade assets carry a higher than normal risk that borrowers may default in the timely payment of principal and interest on their loans, which would likely cause the value of the investment to decrease. Changes in short-term market interest rates will directly affect the yield on investments in floating rate senior loans. If such rates fall, the investment’s yield will also fall. If interest rate spreads on loans decline in general, the yield on such loans will fall and the value of such loans may decrease. When short-term market interest rates rise, because of the lag between changes in such short term rates and the resetting of the floating rates on senior loans, the impact of rising rates will be delayed to the extent of such lag. Because of the limited secondary market for floating rate senior loans, the ability to sell these loans in a timely fashion and/or at a favorable price may be limited. An increase or decrease in the demand for loans may adversely affect the loans.

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Past performance is no guarantee of future results.