US leveraged loan market ends 6-month journey from COVID lows to positive returns

Year-to-date returns in the US leveraged loan market entered positive territory last week, finally recouping the massive losses the $ 1.2 trillion asset class suffered in March. , as the coronavirus shut down economies around the world.

The return to the dark lending lags behind other major asset classes – notably high yield bonds and investment grade debt – which received direct or tacit support from the Federal Reserve after the start of the pandemic. Leverage loans, which have come under intense scrutiny in recent years by regulators and investors due to the overall decline in credit quality and aggressive deal structures, received no significant support from the Fed.

For the record, the annual yield on leveraged loans in the United States was 0.02% on September 16 (it fell to minus 0.01% on September 18).

While it may have been difficult to predict such a comeback, given the record severity of the declines that saw the market drop 12.37% in March alone, it’s not entirely surprising, as the asset class has demonstrated resilience over its 23 years. history (according to the S & P / LSTA loan index). Only once during that time did it finish with an annual return figure in negative territory (2015).

The return to a positive figure for fiscal 2020 against 20.07% on March 23 is all the more impressive given the current climate of rising credit defaults and tightening lending standards, at an unprecedented rate since the Great Financial Crisis. And again, the US Federal Reserve’s initiatives to support capital markets have not been as favorable to leveraged lending as they have been to other asset classes.

Nonetheless, the dip in loan prices certainly matches the Fed’s first program announcement, and loans have also benefited from other favorable technicalities, including new issue volumes behind in 2019, and relatively relatively low demand. strong investors, as evidenced by increasingly frequent conditions favorable to issuers modifications of loans under syndication (reflecting investor demand).

By comparing the performance of the loan market to other asset classes, the change in the value of $ 1,000 invested since the start of 2020 shows how far loans have lagged in other risky markets in the world. reprise. The S&P 500 was hit hardest in March, but the return to par was equally spectacular, with this milestone reached as early as July, while high yield bonds returned to face value in early August, closing at a positive YTD. 0.75%. return before August 31.

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Digging deeper into those secondary market prices, the weighted average supply of the S & P / LSTA Loan Index climbed to 93.96 at the September 16 close, its highest reading since March 8, and 17 , 7 points above the coronavirus-linked low of 76.23 on March 23. .

Looking even closer, after a 38 day streak, through May 7, with no loans rated at par and above, 4.7% of outstanding loans have now passed that level. This compares to 52.9% at the end of 2019 and a 2019 average of 18%.

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The share of loan offers below 80, at 5.1%, although down significantly from the peak of 56.8% on March 23, remains high, compared to the 2019 average of 3.25% . This level of supply below 80 is broadly classified in the category of distressed debt. The current share of deep distress, below 70, at 2%, compares to an average of 1.5% in 2019.

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Investors in the US loan market today remain relatively high-demanding when it comes to credit quality, although the supply level differentials between higher and lower quality assets are narrowing. In general, the average supply of loans rated CCC + (by issuer rating), at 83, represents a differential of 10.7 points compared to loans from issuers rated B-, against 15.81 points at the end of February. The dispersion between single-B credits also declined, with the differential between single-B and B- at 2.96 points, down from the April high of 5.04 points; and single-B, against B +, at 1.43 points, against 2.69 points in April.

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As average prices rise and the quality differential narrows, the share of loans from B-rated issuers priced above 90 is rapidly catching up to loans from BB-rated issuers, according to the index.

The bifurcation, of course, can also extend to segments of the industry. The following graph shows the evolution of the average supply of outstanding loans in various industries, at the end of each month and until September 16. prices were much more differentiated during the market rebound. At the end of 2019, all sectors were valued within a range of 24 points. By March, that had widened to 39 points, with more industries deviating further. Oil and gas, falling to an average supply of 53.7, and retail, falling to 69.7, were behind much of the move. In recent months, as average prices have risen, the spread has narrowed by only six points, to 33.

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On a final note, the volatility of what has historically been a relatively stable US loan market has, unsurprisingly, declined significantly since its crisis peak. The 30-day rolling standard deviation of daily loan yields, which typically ranges from one to five basis points (with spikes over 20 basis points extremely rare), has skyrocketed to 165 basis points in March. This measure has since fallen to seven basis points and is now at the end of February level.

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Priscilla C. Carnegie