In late June several investment banks called, canvassing the market. They wanted
to see if there was still enough demand to syndicate lower Single-B rated deals.
July quickly erased any concern, not only surrounding hung syndications but also
that there would be sustained weakness in the loan market. Demand overwhelmed
supply and the percentage of loans trading above par shot up from 56.1% at the end
of June to 72.2% by the month end.
July loan returns were the strongest of the year, driven primarily by a lack of new
issuance. In fact, less than $13 billion of loans allocated in the month, which marks a
17-month low. The market has averaged approximately $40 billion per month during
the last six months.
Performance
In July 2017, the Credit Suisse Leveraged Loan Index (“CS LLI”) was up 0.78%
and the S&P Leveraged Loan Index (“S&P/LSTA”) was up 0.69%.
- Year-to-date ending July 31, 2017, the CS LLI was up 2.76% and the S&P/LSTA
was up 2.62%.
- For the twelve months ending July 31, 2017, the CS LLI was up 6.83% and the
S&P/LSTA was up 6.64%.
Lower quality continued to outperform higher quality throughout the month with distressed loans netting a return close to 2.2% in
July. Double B and Single B loans returned 0.71% and 0.82%, respectively. Larger, more liquid loans slightly outperformed smaller
term loans during the month.
Sector Performance
Every sector posted a positive return in July, led by Energy (+2.51%), Food & Drug (+1.69%) and Utility (+1.27%).
WTI crude oil was up 8.4% in July and began to move higher on the heels of Saudi Arabia announcing that it would make deep
cuts to exports in August. Energy loans caught a bid in the back half of the month and led all sectors.
News of Amazon entering the bricks and mortar retail grocery business with the acquisition of Whole Foods sent shock waves
through the industry in June. However, investors thought the selloff was overdone and July saw Food & Drug move higher as
several of these borrowers bounced back.
Finally, Utilities also moved higher despite natural gas dropping nearly 8%. Rumors of mergers & acquisitions surrounded many
of the larger players in the industry. This combined with small acquisitions in the space, led to some optimism surrounding
valuations.
Metals/Minerals, Consumer Non-Durables and Consumer Durables were the three worst performing sectors with total returns of
0.52%, 0.44% and 0.09%, respectively.
On a year-to-date basis, Energy, Metals/Minerals, and Services led all sectors with total returns of 4.51%, 4.14% and 3.77%,
respectively.
On a year-to-date basis, Food & Drug, Utility and Retail were the worst performing sectors with returns of 1.70%, 1.29% and
-1.67%, respectively. Retail was the only sector to have negative performance on a year-to-date basis as well as on a trailing 12
month basis.
Total Return by Sector
Source: Credit Suisse Leveraged Loan Index
The flow-name prices in the S&P Index (below) increased during the month before very slight weakness crept in during the
final week.
Average Loan Flow-Name Bid
Source: LCD, an offering of S&P Global Market Intelligence
The average bid of the broader loan Index is up materialy during the last year. By the end of July prices returned to the same levels found in May and early June.
Average Bid of the S&P/LSTALL Index
Source: CS, LLI, LCD, an offering of S&P Global Market Intelligence; S&P/LSTA Leveraged Loan Index
Technical Conditions
CLO new issue supply was $7.9 billion in July down 42% from June, which was the largest inflow in the last 12 months. While CLO issuance declined, it was evident that CLOs printed in June and July were actively ramping and pushing prices higher. Year-to-date, over $58 billion of CLOs have been issued, exceeding most estimates for 2017.
CLO New Issue Volume
Source: LCD, an offering of S&P Global Market Intelligence
Institutional new issue volumes decreased month-over-month by nearly 20% while pro rata new issuance declined over 80%. This, combined with approximately $25 billion in index loans repaying, left investors scrambling to invest growing levels of cash. For the first month since January, the amount of par outstanding loans shrank, in this case by $7.0 billion.
Leveraged Loan Volume
Source: LCD, an offering of S&P Global Market Intelligence
50% of institutional issuance was driven by opportunistic financings (dividends, refinancing/repricing) while 50% of the issuance
was driven by M&A activity.
YTD Institutional Volume
Source: LCD, an offering of S&P Global Market Intelligence
Consistent demand has pushed over 70% of loan borrowers above par. With prices reaching recent highs, and coupons shrinking
via re-pricings and refinancings, the trailing 12-month return has begun to decline..
Inflows and Rolling LTM Returns
Source: LCD, an offering of S&P Global Market Intelligence
Single B spreads in July widened from the prior month although remain 10.2% tighter than 12 months ago. It is important to note
that mix plays a factor in the average spread and that a solid Single B loan, that is a repeat issuer, would price at a tighter level
than the prior month. Double B spreads also reflected a slight widening based on asset mix. Double B loans remain nearly 7%
tighter on a YTD basis and 21% tighter on a y-o-y basis.
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 while Single Bs tightened slightly.
Average New-Issue Yields
Source: LCD, an offering of S&P Global Market Intelligence
There have been 22 defaults in the last twelve months with one in July: True Religion. The LTM default rate increased from 1.17%
to 1.29%, based on a number of defaults while the default rate increased from 1.29% to 1.36% based on par amount outstanding.
Regardless of measurement, default rates remain very low on a historical basis.
Lagging 12-Month Default Rates
GRAPHIC11
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
Retail and Restaurant loans provided seven defaults in the last 12 months while commodity driven loans provided five. This is the
first reading in the last several years when commodity driven loans were not the leading default contributor. The shadow default
activity remains low, suggesting that there will not be any broad-based increase in the next 12 months.
Valuation
Since 1992, the average 3-year discount margin (“DM”) for the CS LLI, is 463 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 was tight to the
historical average, at 423 basis points and 19 basis points tighter than the prior month.
The DM spread differential between double Bs and single Bs has widened from August 2016 to July 2017 by 13 basis points and is
still 31 basis points wide 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 July 31, the S&P/LSTA Index imputed default rate was 1.64%, the lowest level since December 2007. While this is shocking, it also contrasts with the multi-year high in February 2016 of 7.3%.
Technical conditions remained as imbalanced as they have been since the first quarter 2017. Growing CLO demand and stagnant retail fund flows dwarfed an anemic new issuance calendar. The overwhelming demand is leading to higher leverage levels and tighter spreads. While the new issue calendar is expected to pick up, it will not likely occur until after Labor Day. In the interim, loans are likely to continue to grind higher, absent a larger credit risk event.
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