Loan Review – January 2018

Monthly Commentary

February 13, 2018

Up, up and away was the theme in January. Loan prices pushed higher and LIBOR spreads tightened materially. A dearth of merger and acquisition activity resulted in a sparse new issuance calendar to begin the year. With over 40 CLO warehouses actively ramping, demand quickly outstripped supply. The technical imbalance allowed new issue single B spreads to gap tighter by 37 basis points from December.

The average new issue spread for double Bs and Single Bs hit levels not seen since February 2009 and May 2010, respectively.

 

The broader CS LLI had spreads reaching a post crisis low of 346 basis points. The fear of rising rates drove investors into more floating rate products, helping to push 80.0% of loans in the JPMorgan Leveraged Loan index above par, a level not seen since January 2014.

Spreads Finish the Month at New Post-Crisis Low

Source: Credit Suisse

The 3-year discount margin reached a pre-financial crisis level of 391 basis points. This is the tightest 3-year discount margin since October 2007.

Performance

In January, the Credit Suisse Leveraged Loan Index (CS LLI) and the S&P Leveraged Loan Index (S&P/LSTA) were both up, 1.08% and 0.96%, respectively. This was the sixth best monthly return for the CS LLI in the past five years.

  • For the 12 months ending January 31, 2018, the CS LLI was up 4.81% and the S&P/LSTA was up 4.54%.

Split triple C and split single B loans provided the strongest returns both in January and during the last 12 months. In fact, split single B returns more than doubled the return of higher quality loans both in January and during the last 12 months.

Source: Credit Suisse Leveraged Loan Index

Sector Performance

Every sector in the Credit Suisse LLI provided a positive return during the month while the top performing sectors in January were Consumer Durables (+3.30%), Retail (+2.73%) and Utility (+2.16%). Consumer Durables was driven by one large, levered mattress retailer that rallied back from a large decline in November. Retail and Utilities have lower average price borrowers that also rallied back closer to par with retail benefiting from many positive flash results and Utilities benefiting from a cold winter and high gas prices.

The worst performing sectors for the month were Forest Products/Containers (0.64%), Chemicals (0.72%) and Gaming/ Leisure (+0.73%).

In the last 12 months, Metals, Manufacturing and Service led all sectors with total returns of 7.21%, 5.80% and 5.73%, respectively. In contrast, Retail, Energy and Consumer Durables were the worst performing sectors with returns of 0.74%, 2.66% and 2.68%, respectively.

Source: Credit Suisse Leveraged Loan Index
Green Returns= Best Performing Sector; Red Returns= Worst Performing Sector.

The average bid of the S&P LCD’s flow-name loan composite came in at 100.03% of par, over 50 basis points higher than month-end December (99.47%).

Average Loan Flow-Name Bid

Source: LCD, an offering of S&P Global Market Intelligence. As of January, 2018.

The CS LLI hit its highest price since September 2014, demonstrating just how strong demand for loans was in the month of January.

CS LLI Average Price (9/2014 –1/2018)

Source: CS LLI

Technical Conditions

CLO markets remained busy in January, in contrast to the beginnng of 2017. Over $6 billion of new deals priced during the month, which is typically a quiet period. Expectations for 2018 CLO issuance from Credit Suisse have been increased to $120 billion, surpassing 2017 issuance.

CLO Volume

Source: LCD, an offering of S&P Global Market Intelligence

Leveraged loan funds reported an inflow in January of -$1.62 billion. In fact, 19 of the last 22 weeks have registered retail fund outflows.

Leveraged loan funds reported a second consecutive weekly inflow for the asset class in January following fourteen consecutive outflows. Inflows year-to-date for loan mutual funds have been $408 million. The asset class is experiencing steady inflows for the first time since July as the surge in 10 year U.S. Treasury yields has directed attention to rate risks across fixed income. AUM for the leveraged loan retail base is $141 billion, which is comparable to the peak in 2014 of $154 billion.

There was nearly $47 billion of new issue placed in January, almost 32% more than the prior month. However, higher issuance levels only increased the index size by $10 billion as repayments and quarterly amortization payments materially offset the new issue calendar.

Leveraged Loan Volume

Source: LCD, an offering of S&P Global Market Intelligence

In terms of the new issuance, roughly 25.6% of the primary market was related to refinancing existing deals while acquisitions and LBOs accounted for 57.2% of new issuance. If amendment activity is included, then the mix of issuance so far this year has been 60% refi/repricing driven and 40% M&A and GCP related.

January 2018 Institutional Volume

Source: LCD, an offering of S&P Global Market Intelligence. As of January, 2018.

The repricing volume is still dominated by amendments as compared to syndication withnearly 80% of all repricing activity completed via amendment. The first quarter and the fourth quarter tallied most of the activity as can be seen on the following page.

Monthly repayments fell to $16 billion following several months of high repayment activity. This decline eased the technical imbalance in the market.

Monthly Repayments in the S&P/LSTA LL Index

Source: LCD, an offering of S&P Global Market Intelligence. As of January, 2018.

Despite strong inflows, the trailing 12-month returns continued to move lower throughout the year. The combination of lower LIBOR spreads and price declines resulting from repricing activity weighed on returns.

Inflows and Rolling LTM Returns

Source: LCD, an offering of S&P Global Market Intelligence. As of January, 2018.

New issue spreads in January were -2.0% tighter for double Bs and -10.0% tighter for single Bs as compared to the prior month. The index spread for the CS LLI ended December at roughly L+355 basis points. This is the tightest spreads have been for the CS LLI index since March 2011.

Source: LCD, an offering of S&P Global Market Intelligence. As of January, 2018.

Average new issue yields widened month-over-month for Double Bs (0.60%) and were -0.04% tighter for single Bs. Rising LIBOR essentially offset tighter LIBOR spreads in 2017. In January, 3-month LIBOR moved higher by another 8 basis points.

Average New Issue Yields

Source: LCD, an offering of S&P Global Market Intelligence. As of January, 2018.

The default rate of the S&P/LSTA Leveraged Loan Index declined to 1.95% by principal amount in January, despite two new defaults. This level is dropping from a 17-month high of 2.05% at the end of December.

The two defaults brought the last 12-month default tally to 27 and both of the new contributors were Energy borrowers: Philadelphia Energy Solutions and Fieldwood Energy.

Source: LCD, an offering of S&P Global Market Intelligence. As of January, 2018.
* Shadow default rate includes potential defaults, including those companies that have engaged bankruptcy advisors, performing loans with SD or D corporate rating and those paying default interest.

Oil & Gas and Retail dominated the defaulted loans, each with seven defaulted borrowers, contributing to over 50% of the default rate.

Valuation

Since 1992, the average 3-year discount margin (“DM”) for the CS LLI, is 462 basis points. If the global financial crisis (2008 & 2009) is excluded, the 3-year discount margin for the CS LLI is 417 basis points. At month end, the 3-year DM (391 basis points) and was the tightest 3-year discount margin since October 2007.

The DM spread differential between double Bs and single Bs has widened from February 2017 to January 2018 by 18 basis points and is still 41 basis points wide of the historical spread differential.

Source: Credit Suisse

Summary

As of January 31, the S&P/LSTA Index imputed default rate was 1.25%, the lowest level since October 2007.

January performance was driven by the same characteristics that dominated 2017. CLO issuance and loan demand overwhelmed loan supply. Despite a very favorable capital market environment, we are not seeing a high level of merger and acquisition activity. Global demand for CLO investment remains very strong, pushing both CLO liabilities and CLO collateral tighter.

LIBOR continues to rise, bringing more investors into floating rate retail funds. All of this demand has resulted in a stair-step tightening of LIBOR spreads.

It is shocking to begin 2018 and see the 3-month discount margin and imputed default rate for the CS LLI and S&P LLI reach pre-crisis levels. It is also notable that many new issues in January priced at levels comparable to pre-crisis rates.

In order to change the technical environment, there would need a prolonged and sustained decline in the broader fixed income and equity markets to overwhelm current demand. Without such a disruption, loan demand will continue to drive prices higher.

 

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