Loan Review – March 2018

Monthly Commentary

April 13, 2018

How prophetic…the Ides of March, the day when ancient Romans would settle their debts, served as the demarcation point for when loans began to weaken. Similar to the Roman Practice, in late March, loan investors felt like it was time to pay the piper. Loan prices dropped 12 basis points after March 15th and the Credit Suisse Leveraged Loan Index (“CS LLI”) ending the month at 98.19, its lowest price since Valentine’s Day. While loans represented a bastion of stability relative to most of the capital markets, prices did weaken for the second consecutive month.

As CLO liability spreads began to widen, loans experienced pressure. Most of the pressure was reflected in the primary market, particularly within single Bs. In the beginning of March, investment banks hurried out a host of deals, looking to reprice or lower their LIBOR spreads. There seemed to be little justification for the levels discussed, meaning each deal pushed the envelope in terms of spread tightening. Needless to say, these types of deals were getting done in January, February and the beginning of March. While double B new issue still priced at the tight end of “talk,” single B deals began to fail at price talk. Deals priced at the wide end of talk or even wide of talk. Meanwhile, the secondary market largely remained stable as the percentage of loans trading above par stood at 73.3%, not far below the year-to-date high (80.0%).

Demand for loans remained intact as inflows from retail funds continued to be positive, primarily as a result of the climbing LIBOR rate.

Surge in LIBOR in 1Q18

Source: Credit Suisse, Bloomberg

The primary calendar continued to be dominated by repricing activity as spread compression has been a major theme of 2018 despite secondary price weakness in February and March.

Source: TCW

As mentioned in our last commentary, the repeal of risk-retention requirements for CLOs was announced in February. However, the opportunity for the government to file an appeal to the United States Circuit Court for the DC Circuit expired at midnight on March 26th with the agencies choosing not to pursue further action. On April 5th, the DC Court ordered a summary judgement granted in favor of the The Loan Syndications and Trading Association (LSTA), vacating the prior ruling. For practical purposes, CLO managers are no longer subject to the U.S. risk retention rule.

Performance

In March, the CS LLI and the S&P Leveraged Loan Index (“S&P/LSTA”) were both up, 0.32% and 0.28%, respectively.

  • For the quarter the CS LLI was up 1.58% and the S&P/LSTA was up 1.45%.
  • For the 12 months ending March 31, the CS LLI was up 4.64% and the S&P/LSTA was up 4.43%.

Lower quality loans (Split B, CCC and distressed) still provided the strongest returns in March despite market weakness in the back half of the month. During the last 12 months, higher quality lagged lower quality. Single Bs provided a return of 5.6% while Double B loans returned 4.04%.

Source: Credit Suisse Leveraged Loan Index

Sector Performance
Nineteen of 20 sectors in the Credit Suisse LLI provided a positive return during the month led by Transportation (+0.63%), Metals (+0.57%) and Retail (+0.57%).

The worst performing sectors for the month were Consumer Durables (-1.66%), Consumer Non-Durables (0.03%) and Food / Tobacco (0.22%).

In the last 12 months, Metals, Manufacturing, and Financials led all sectors with total returns of 5.55%, 5.54% and 5.38%, respectively. In contrast, Consumer Durables, Retail and Consumer Non- Durables were the worst performing sectors with returns of -2.52%, 2.42% and 2.52%, respectively. Fear of the Amazon effect and the changing landscape of consumer shopping habits have pushed these sectors lower during the last year.

Total Return by Sector

Source: Credit Suisse Leveraged Loan Index

The average bid of the S&P LCD’s flow-name loan composite came in flat from the prior month at 99.62%.

Average Loan Flow Name Bid

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

Technical Conditions
In March, CLO markets printed $10.7 billion of new deals as demand for liabilities began to waiver. Liability spreads pushed wider in the back half of the month after an overwhelming number of deals were reset following the changes to risk retention requirements. However, issuance remained robust and the pipeline remains very large.

CLO Volume

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

Leveraged loan funds reported an inflow in March of $2.9 billion. Following two weak months of retail inflows, March inflows surged higher as 3-month LIBOR topped 2.3%.

For the first quarter overall, net inflows into retail funds totaled $3 billion, starkly different from the $3.7 billion of redemptions in Q4 2017.

March institutional issuance picked up from the prior month.

Leveraged Loan Volume

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

In terms of the year-to-date new issuance, roughly 36.2% of the primary market was related to refinancing existing deals while acquisitions and LBOs accounted for 48.9%.

Month-to-date, $85.1 billion of institutional loans have priced, 72% of which has been re-pricing ($43.8 billion) or refinancing ($17.3 billion). While total institutional loan volume equates to $218 billion year to date and is down 32% y/y, the $70 billion of net issuance (ex-re-pricing/refinancing) is 11% ahead of last year’s pace.

Institutional Volume YTD

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

Monthly repayments accelerated to nearly $35 billion at quarter end, which created a technical pressure for investors to find more assets.

Monthly Repayments in the S&P/LSTA LL Index

Sources: LCD, an offering of S&P Global Market Intelligence; S&P/LSTA Leveraged Loan Index

Amid strong inflows, the trailing 12-month returns continued to pace close to 4.5%. The combination of lower LIBOR spreads and price declines resulting from repricing activity have weighed on returns.

Inflows and Rolling LTM Returns

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

On a year-to-date basis, new issue spreads in March are -3.8% tighter for double Bs and -9.2% tighter for single Bs. The Index spread for the CS LLI ended March at roughly L+352 basis points. This is the tightest spreads have been for the CS LLI index since March 2011.

New Issue Spread Changes

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

Average new issue yields widened month over month for Double Bs (0.08%) and contracted for single Bs (-0.01%). Rising LIBOR has offset much of the tighter LIBOR spreads during the last 12 months. In March, 3-month LIBOR moved higher by another 29 basis points.

Average New-Issue Yields

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

The default rate of the S&P/LSTA Leveraged Loan Index remained flat at 2.00% by principal amount in March. There were three defaults (Claire’s Stores, Clear Channel Communications and Harvey Gulf). This level is still down from an 18-month high of 2.05% at the end of December.

The last-12-month default tally is 27. Retail defaults lead all categories with eight while Oil & Gas is close behind with six.

 

Lagging 12-Month Default Rates

Source: LCD Loan Stats

* 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

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 (396 basis points) and excluding January, this was the tightest 3-year discount margin since October 2007.

The DM spread differential between double Bs and single Bs tightened by 11 basis points from April 2017 to March 2018 and is still 38 basis points tighter of the historical spread differential.

3-Year Discount Margin Differential Between BBs and Single Bs

 

Source: Credit Suisse Leveraged Loan Index

CS LLI Snapshot

Source: Credit Suisse Leveraged Loan Index

Summary
As of March 31, the S&P/LSTA Index imputed default rate was 1.17%, its second lowest level since October 2007.

Loans represented a stable asset class relative to the broader capital markets. Loans outperformed high yield bonds for a sixth consecutive month. LIBOR’s rise brought retail fund flows in and a long line of CLOs pricing brought significant demand. However, the market felt generally weak as the month ended despite positive flows and a moderate new issue calendar.

As CLO liabilities widen, conventional wisdom would suggest that the collateral will widen as well. However, as we look ahead to April, numerous CLOs are trying to source paper and loans appear to be rebounding again. This demand, combined with a high level of repayments in March left many managers with significant cash to put to work in April.

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This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. The information contained herein may include preliminary information and/or "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. TCW assumes no duty to update any forward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are subject to change without notice. Past performance is no guarantee of future results. © 2018 TCW