Analysis of the US leveraged loan market; Video, Graphics
The loan market cooled slightly in August in response to lower investor sentiment and somewhat weaker technical conditions. Looking ahead, the supply of new M&A-driven issues is expected to increase in the latter part of the year.
Examination of details:
The S&P/LSTA index fell slightly in August, losing six tenths of a percent, after climbing one percent in July. The decline partly reflects the general decline in financial markets. Moreover, as we will see below, the technical situation in the loan market weakened somewhat in August. Yet, with interest rates rising, loans were the big relative value winners in August, outperforming equities, HY, corporate bonds and Treasuries.
The loan market’s outperformance was the result of demand for the asset class. Indeed, the rate hike captured the attention of retail investors. As a result, assets under management for lending mutual funds rose by a record $9 billion during the month according to Lipper IMF and fund filings. Additionally, CLO issuance rebounded to $6.4 billion from a 12-month low of $3.4 billion in July.
However, as impressive as these numbers are, supply has increased even more dramatically. In total, outstanding loans in the S&P/LSTA index rose $20 billion to a record $625 billion. This excess of supply over inflows helped moderate loan prices in August.
Despite this, the new issue market remained robust in August. Offset returns fell across the board as managers sought to bring new capital flows to bear.
Likewise, the share of the market that cleared the covenant-lite push rebounded.
Regarding credit conditions, the default rate fell from 2.0% in July to 2.2% in August due to the default of Longview Power. However, the managers remain constructive on the short-term outlook. On average, they expect the rate to drop to 1.8% by December according to the latest survey of LCD buyers conducted in mid-June.
Looking ahead, participants are optimistic about the supply, given that the timing of M&A-related loans is now at a high after the credit crunch. To the extent that volume is in line with expectations, participants speculate that loan prices will be constrained in the fourth quarter, assuming, of course, that there are no exogenous disturbances. If so, the environment for raising new capital will remain conducive. However, if supply falls below today’s optimistic forecast, managers fear that technicals could shift back in favor of issuers, compressing CLO arbitrage and limiting lending appeal to retail investors. and institutional.
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