Single B Loan Outperformance Leads to Positive Returns for Loans and CLOs in November

Loan & CLO Review

December 11, 2019

What a difference a month makes. In October, the loan market was taking body blow after body blow but in November it bounced back with little concern for the prior month’s damage.

The most interesting themes can be grouped into three categories. First, demand for higher-quality paper remains robust. The month’s demand was so strong that we saw $23.2 billion of refinancing activity, which included a significant amount of double-B loans. These double Bs generally repriced to spreads inside of L+200. Second, we saw single Bs outperform double Bs and this was a clear departure from what had taken place for most of 2019. It is interesting that investors are again willing to take on more single B risk. The third theme is price dispersion. Despite the rally in the market, we saw a number of industries (primarily commodity driven) still plagued by headline news. Furthermore, while there were fewer earnings misses relative to Q2 2019, the triple C cohort of loans continued to be left behind.

There is perhaps one other emerging trend we have noticed and it is regarding news and our market’s ability to understand what is a legitimate source and what is not. The term ‘fake news’ is perhaps over-used. Having said that, we have noticed a trend of journalists writing opinionated stories on loan borrowers. In two recent cases, both stories seemed to have been sensationalized. We researched the sources and we found neither story held merit. However, the common theme of both was that private equity is bad for business. While these stories selectively chose facts to support a preconceived argument, as opposed to just report on a story, they did create nervousness and real price declines. One of the two borrowers clawed back most of those losses and the other did not. In either case, there is a growing amount of misinformation and opinionated stories seeking clicks rather than truth, which feels new to the loan market.

Performance – Loans

In November 2019, the Credit Suisse Leverage Loan Index (CS LLI) and the S&P Leveraged Loan Index (S&P/LSTA) were up 0.55% and 0.59%, respectively.

  • Year-to-date, ending November 30, the CS LLI was up 6.46% and the S&P/LSTA was up 6.94%
  • For the 12 months ending November 30, the CS LLI was up 4.02% and the S&P/LSTA was up 4.21%

During the month, single Bs outperformed all other categories followed by double Bs and triple Bs. Performing loans were well bid, however, triple Cs and distressed loans provided negative returns and trailed all other categories.

On an LTM basis, higher quality outperformed lower quality as triple Bs and double Bs produced returns of 5.84% and 5.68%, respectively. Single Bs provided a 3.99% return while triple Cs and the distressed categories posted negative returns.

Total Return by Rating

Source: Credit Suisse Leveraged Loan Index

Sector Performance

Fifteen of 20 sectors in the CS LLI provided positive returns for November. The top performing sectors were Food & Drug (1.19%), Information Technology (1.17%) and Retail (1.16%).

The worst performing sectors for the month were Consumer Durables (-0.29%), Metal/Minerals (-0.97%) and Energy (-1.95%). There was a 314 basis point difference between the top and bottom sectors in November.

In the last 12 months, Housing, Aerospace and Financials have led all sectors with total returns of 6.65%, 6.27% and 6.14%, respectively. Metals/Minerals, Energy, and Consumer Durables provided the worst performing sectors with returns of -7.92%, -6.75% and -1.84%, respectively.

Industry Returns

Source: Credit Suisse Leveraged Loan Index

CS LLI prices (excluding defaults) increased 44 basis points (bps) in November while the average bid of the S&P LCD flow-name loan composite increased 37 bps from 99.13 to 99.49. The average flow name bid is up 426 bps on a year-to-date basis.

Average Loan Flow-Name Bid

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

Performance – CLOs

After producing negative returns in October, CLO performance improved in November. CLOs returned 0.51% during the month with positive returns across all tranches. CLOs outperformed Investment Grade (IG) and High Yield (HY) credit and underperformed Loans during the month. YTD, CLOs have returned 4.72%, continuing to underperform Loans, HY and IG.

November CLO performance was driven by the strength in mezz, particularly BBB and BB tranches. The aforementioned positive performance in loans provided a much needed boost for CLOs through higher MVOC coverage. As a result, we saw CLO BBB and BB spreads tighten anywhere from 20-50 bps. However, given that the loan rally was not evenly distributed (i.e. many of the distressed loans remained at distressed prices), tiering in CLO mezz remained wide as deals that held a disproportionately higher amount of distressed loans traded wide to deals that had less exposure to loans priced under $80.

Moving up the capital stack, CLO AAA spreads tightened 5 bps due to lower supply in secondary and compelling value following October’s widening. AA spreads remained flat with a thin amount of volume trading. Single As tightened slightly; however, the basis within single As did narrow as loans prices improved.

Equity NAVs increased 1-3 points. November equity payments ranged between 2.5-4.5%. Cash-on-cash equity distributions continue to slowly increase as the median WAS in CLO portfolios has remained stable to slightly higher over the year.

Secondary CLO activity declined in November with only $2bn in BWIC volume, half the amount in October. Per TRACE, much of the decline was in IG volume with non-IG TRACE volume similar to October levels.

Secondary CLO 2.0 Total Returns

Source: JPM CLOIE Index

Secondary CLO 2.0 Spreads (DM)

Source: TCW

Technical Conditions – Demand

Leveraged loan fund flows have been negative 53 out of the last 54 months. Outflows since the beginning of 4Q18 total $56 billion or 35% of beginning period AUM. AUM for the loan mutual fund base is down to $98 billion from as high as $154 billion in October 2018. For context, loan retail funds now hold less than 8% of outstanding loans versus a peak of 20% in 2013. Outflows for loan funds total -$36 billion which compare to +$5 billion of inflows YTD18.

CLO new issuance declined slightly over the month with $9.6bn pricing across 21 deals. AAA levels remained firm with Tier 1 AAAs pricing between 133 and 134 dm. Mezz spreads tightened over the month, with BB spreads 50-75 bps tighter. Tier 1 BBs went from 800 dm at the start of November to 725 dm by month end. BBB new issue spreads also tightened 40 bps with tier 1 BBBs now pricing inside of 400dm.

Refi activity slowed down with only two refis and three resets pricing over the month vs. nine refis and one reset in October. Refi activity should remain low in the near future as most Q4 2017 / Q1 2018 deals that are eligible to be refinanced over the next few months have AAA spreads in the low 100s dm. Unless AAA spreads tighten and/or the term curve significantly steepens, refinancing would seem out of the money on many of these deals.

Of the 21 new issues that priced over the month, five (or 24% by count) were Middle Market CLOs. Most of these deals were issued as EU compliant with a 4 year reinvestment period. AAA spreads were in the 175-180 dm range.

There were also three new issue BSL deals that priced with shorter (2-3 year) reinvestment periods. AAA spreads on these deals ranged from 125 – 132 dm.

Tier 1 CLO weighted average cost of debt declined by 10 bps to 195 bps due tighter BBB and BB spreads. However, with new issue BB loan spreads tighter over the month, arbitrage declined to 160 bps.

CLO New Issuance

Source: TCW

New Issue BSL AAA DM – November

Source: TCW

Tier 1 New Issue Spreads (5 yr reinv)

Source: TCW

Technical Conditions – Supply

November continued to see an increase in refinancing activity, marking a monthly high for 2019. Double B loans, which are in high demand, opportunistically hit the market at generally reduced LIBOR spreads (to L+175). On a year-to-date basis, M&A and LBO activity has accounted for roughly 58% of new issues while in November, M&A and LBO activity only accounted for 38% of new issuance.

Institutional New-Issue Volume by Purpose

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

YTD US CLO new issue supply of $110 billion is now down -9.9% year-over-year but pacing to produce the third strongest year in CLO history. November saw $9.7 billion of issuance as Q4 2019 paces to be the second largest CLO issuance quarter of the year. Solid CLO inflows and mild retail outflows allowed for strong returns during the month.

Inflows and Rolling LTM Returns

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

New issue spreads in November tightened -4.93% month over month and were -25.2% tighter on a year-to-date basis. It is important to understand the change in mix. The calendar in November was dominated by higher quality refinancing activity; average spreads appear to be tightening considerably. However, if you look just at the single B new issue spread, it was only -1.0% tighter than the prior month and 5.8% wider since June.

New Issue Spread Changes

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

In terms of new issue yields, yields continued to decline primarily as a result of a declining LIBOR rate and tightening double B spreads.

Average New-Issue Yields

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

Fundamentals – Loans

Lagging 12-Month Default Rates

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

There were two loan defaults in November. The default rate changed from 1.43% in October to 1.63% in November, based on par outstanding.

The last 12-month default tally for the S&P/LSTA Index is 23. Services & Leasing leads all categories with five defaults, followed by Retail and Oil & Gas, each with four defaults.

As of November 30, the S&P/LSTA Index imputed default rate was 2.91%, down from 3.09% in the prior month.

Fundamentals – CLOs

CLO fundamentals continued to deteriorate with WARF levels rising due to a slight increase in B3 and CCC rated assets. Junior OC cushions declined 5-10 bps over the month and the percent of loans trading below $80 in CLOs increased 50 bps to 5.5%. Due to the uneven rally in loan prices CLO MVOC improved for many deals but not all with the range of BB MVOCs widening to over 5%.


Since 1992, the average 3-year discount margin (“DM”) for the CS LLI is 460 bps. If the global financial crisis (2008 & 2009) is excluded, the 3-year discount margin for the CS LLI is 418 bps. The 3-year DM finished the month at 498 bps, which tightened 28 bps from the prior month.

The DM spread differential between Double Bs and Single Bs is 93 bps wider from December 2018 to November 2019 and 57 bps wider than the historical spread differential since inception.

3-Year Discount Margin Differential Between BBs and Single Bs

Summary and Looking Forward

November price action reversed the risk-off sentiment in October. As we enter December, CLO investors are well aware of looming year-end amortization payments and the fact that the forward calendar has less than $10 billion of deals in syndication. The lack of supply and the pending pay downs combined with large CLO demand have contributed to a risk on sentiment. The primary market continues to be dominated by opportunistic higher-quality deals, which will reduce existing LIBOR spreads. Borrowers can be more aggressive in repricing deals in this environment. While a general skittishness remains for distressed credits, we have continued to see a strong risk on attitude as December CLOs price and ramp.

We estimate about $6-$7bn of CLOs left to price this year, which would bring 2019 CLO issuance close to $118bn, not too far off from 2018 issuance at $128bn. Given the manageable supply, CLO spreads should remain rangebound at the top of the capital stack. Mezz levels will be highly dependent on loan prices but given the tightening we have seen over the past month coupled with the slow down into year end, we don’t expect mezz levels to dramatically tighten / widen for the remainder of 2019.



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