Loan Review – August 2018

Monthly Commentary

September 13, 2018

August was the slowest month of the year as measured by new issue loan activity and the last two weeks of the month felt like the trading desks were operating with skeleton crews. Given the seasonal slowdown, it seems like a good time to take stock of where we are and where we are heading.

The CLO machine had been operating at full tilt for most of the year and August was no exception. Year-to-date CLO new issue (excluding refinancings) had reached $95 billion. JPM forecasts $130 billion of new U.S. CLO supply in FY 2018 (or $245 billion total gross volume). CLO outstandings are now $571 billion versus $519 billion at YE 2017 and $314 billion five years ago. With three months left in the year, it is certainly conceivable that a new all-time issuance record will be set in 2018. At the same time, retail floating rate mutual fund AUM also climbed within $3.0 billion of an all-time high. With weekly reported inflows 31 of the past 33 weeks, it is easy to believe that record may be eclipsed as well. With so much demand and little supply in August, it felt like loans could have climbed significantly higher but instead the month finished with less than 50% of loans trading above par.

While the loan market took a breather, we saw emerging markets hit dramatically and the equity markets took a step backward. Argentina, Turkey and Indonesia dominated headlines, all against a backdrop of a pending trade war between the U.S. and China. With broader markets feeling a bit more sensitive, we saw CLO liabilities drift wider again. CLO liabilities reached levels last seen in the fall of 2017. As a reminder, loan spreads were roughly 15 basis points wider last fall and loan 3-year discount margins were nearly 100 basis points wider.

Historical Spreads

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

What does this mean for our market? It means managers are a little bit more reluctant to chase deals above par. It means that the current batch of new issue will likely have a higher hurdle to clear. And it means that deals that are highly levered / lowly-rated may have a more difficult time clearing without paying a pound of flesh (i.e. higher interest burden).

Performance

In August 2018, the Credit Suisse Leveraged Loan Index (CS LLI) and the S&P Leveraged Loan Index (S&P/LSTA) were up 0.41% and 0.40%, respectively.

  • Year-to-date, ending August 31, the CS LLI was up 3.26% and the S&P/LSTA was up 3.32%
  • For the twelve months ending August 31, the CS LLI was up 5.29% and the S&P/LSTA was up 4.88%

Triple C and Split Single B led all categories in the month while Distressed loans were the worst performing category. By and large, par loans clustered around 40 basis points, slightly below the average monthly coupon.

Total Return By Rating

Source: Credit Suisse Leveraged Loan Index

Sector Performance

Nineteen of the 20 sectors in the CS LLI provided a positive return during the month. The top performing sectors in August were Retail (+1.11%), Consumer Non-Durable (+0.71%) and Transportation (+0.66%). Retail has been driven the last several months by generally good quarterly results as well as the compression between higher beta stressed borrowers and par loans.

The worst performing sectors for the month were Utility (+0.19%), Food/Tobacco (+0.18%) and Media/Telecom (-0.03%).

On a year-to-date basis, Retail (+7.78%), Metals/Minerals (+6.71%) and Energy (+5.94%) outperformed.

In the last 12 months, Metals, Energy and Retail have led all sectors with total returns of 9.94%, 9.91% and 8.45%%, respectively. In contrast, Food/Tobacco, Consumer Non-Durables and Consumer Durables were the worst performing sectors with returns of 4.29%, 3.28% and -2.54%, respectively.

Industry Returns

Source: Credit Suisse Leveraged Loan Index

CS LLI prices decreased -1 basis point in August while the average bid of the S&P LCD flow-name loan composite drifted 7 basis points from 99.65 to 99.58.

Average Loan Flow-Name Bid

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

Technical Conditions

Leveraged loan funds reported an inflow of $633 million for the rolling four-week period. This takes the assets under management to $150 billion for the dedicated loan mutual fund base, which compares to an all-time high of $154 billion in April 2014. Inflows year-to-date for loan mutual funds totaled +$14.3 billion compared to a +$13.1 billion inflow in 2017 during the same period.

JP Morgan reported gross CLO volume to be $27.0 billion in August, which includes $13.9 billion ex-refi/reset/re-issue activity. Gross CLO volume totaled $202 billion on a year-to-date basis. This S&P Monthly net CLO issuance can be seen below.

CLO Volume

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

Institutional new issuance declined to $11.3 billion in August, which was not only the lightest month in 2018 but was the lightest month of issuance for loans since February 2016. On a year-to-date basis, institutional new issue is down 8.6% from the first eight months of 2017.

Leveraged Loan Volume

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

Repricings, which dominated the loan landscape for the past year and a half, have disappeared amid the price volatility that began at the end of May. There were few traditional loan repricings over the past month. In fact, repricings represented less than 19% of total new issuance while acquisitions and LBOs accounted for 67%. On a YTD basis, acquisitions and LBOs represented 44% of new issuance.

August New Issue by Purpose

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

Amid strong inflows, the trailing 12-month returns continued to pace slightly below 5.0%.

Inflows and Rolling LTM Returns

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

August saw new issue spread tighten month-over-month. On a year-to-date basis, new issue spreads in August were 1.0% wider for Double Bs and -1.7% tighter for Single Bs. Spreads during the last twelve months have traded in a range that was at its tightest between January 2018 and May 2018. The spread for the CS LLI ended August at roughly L+346 basis points. Excluding June and July, this is the tightest spreads have been for the CS LLI since September 2010.

New Issue Spread Changes

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

In terms of new issue yields, Double Bs and Single Bs widened 20 and 30 basis points, respectively. On a year-to-date basis, Double B yields and Single Bs are both 151 basis points wider. Most of this was driven by 3-Month LIBOR as it was up 62 basis points during the year.

Average New-Issue Yields

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

There were no defaults in August and the rate was unchanged from the prior month at 1.99%.

The last 12-month default tally for the S&P/LSTA Index is 19. Oil & Gas defaults lead all categories with 6 while Retail is close behind with 4.

Lagging 12-Month Default Rate

Source: LCD Loan Stats
* Shadow default rate includes potential defaults, including those companies that have engaged

Valuation

Since 1992, the average 3-year discount margin (DM) for the CS LLI is 460 basis points. If the global financial crisis (2008 & 2009) is excluded, the 3-year DM for the CS LLI is 416 basis points. At month end, the 3-year DM (388 basis points) hovered close to the same level it has been at for all of 2018, which is its tightest since October 2007.

The DM spread differential between Double Bs and Single Bs has widened from September 2017 to August 2018 by 6 basis points and is still 39 basis points wider than the historical spread differential.

3-Year Discount Margin Differential Between BBs and Single Bs

Source: Credit Suisse Leveraged Loan Index

Summary & Looking Forward

As of August 31, the S&P/LSTA Index imputed default rate was 1.21% and, with the exceptions of April and July 2018, this was its tightest level since October 2007.

As mentioned in previous monthly updates, the bank loan market has been driven by technical characteristics for some time. The forward calendar (supply) is swelling close to $50 billion and the net forward calendar is nearly $25 billion. $50 billion is large enough that we would expect when these deals allocate, they will weigh on secondary loan prices. However, we are not expecting to see any great weakness from the new issue calendar simply because the market has a robust pipeline of CLO warehouses looking to pick up any loans that begin to weaken.

Finally, in terms of pricing, CLO liabilities levels should prevent dealers from aggressively flexing spreads tighter. The $8.0 billion Thomson Reuters term loan will likely serve as a bellwether for the September new issue calendar. Given the deal’s size and rating (corporate family rating - B3), a successful syndication will be critical to the entire calendar.

 

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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