As conditions remain competitive in the U.S. leveraged loan market — there has been renewed demand for the asset class in 2021, with investors seeking floating-rate securities and reaching for yield — the difference between secondary market prices on loans with facility ratings of double-B and single-B has compressed to its tightest level in nearly seven years. Indeed, the average bid of the lower-rated loan subset has almost overtaken that of higher-rated names, with the single-B rated index priced at 99.06 as of May 17, compared to 99.13 for the BB rated portion, according to LCD.
The current spread of double-B and single-B prices compares to the long-term average of 3.15 points, dating back to April 2007, when the S&P/LSTA Leveraged Loan Index started pricing daily. Excluding the more volatile financial crisis era, however, the average spread between the two segments is 1.79 points (this entails the past 10 years, from May 2011 through the present). While that figure is significantly below the longer-term average, it is well above the current level.
At a spread of just 7 basis points, the differential between BBs and Bs is the tightest it has been since September 2014, when it also dropped to less than 10 basis points. The five-day stretch in September 2014 came at the end of a 10-month run, from late November 2013 through late September 2014, in which the gap remained under 20 bps — it even went negative from Feb. 18 through April 3 of 2014, topping out with a single-B average bid that was 17 bps higher than the average bid on double-B facilities.
The current emphasis on investor reach for yield is reflected in the yield to maturity of the respective rating categories, with both being driven to near all-time lows, and the spread between the two at its lowest level since the end of November 2018. The yield to maturity of the BB rated portion of the index stands at just 3.19%, 10 basis points atop the all-time low of 3.09% achieved on Feb. 19 of this year, while the single-B yield to maturity is 4.46% as of May 17, just 1 basis point off the all-time low of 4.45%, also on Feb. 19, according to LCD.
For reference, the size of the single-B rated portion of the overall S&P/LSTA Leveraged Loan Index has increased steadily over the past several years, currently representing 60.6% of the $1.2 trillion U.S. leveraged loan market, compared to 53.1% less than three years ago, at the end of 2018. Meanwhile, the BB rated loans account for 20.4% of the index currently, compared to 26.8% at the end of 2018.
Demand has clearly skewed down the rating spectrum so far this year, as investors have looked for assets with more yield, and as concerns over default risk have dissipated, what with a more rosy outlook for the economy going forward (inflation notwithstanding). According to LCD's most recent quarterly investor survey, a majority of respondents believe that the default rate in the current default cycle has already peaked. The U.S. leveraged loan default rate by amount of the S&P/LSTA Index fell to just 2.61% by the end of April, down from 3.15% in March, and is below the historical average of 2.90%.
The improved outlook and declining concern of credit risk has been reflected in the year-to-date returns of the respective ratings buckets of the S&P/LSTA Index so far this year. The triple-C rated portion of the index (by facility rating) has returned a whopping 8.38% in 2021 through May 17, compared to 2.04% and 1.16% for the single-B and double-B rated cohorts, respectively, in the same period. That is the best start to the year for the triple-C rated portion of the index since 2016, when it returned 8.52% through May 17.