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European loans stay in the black overall, but market-value return runs negative

The S&P European Leveraged Loan Index has stayed in the black for another month with a 0.15% return (excluding currency) in July, stretching its sequence of positive returns to 16 months. On a rolling 12-month basis, the ELLI has now returned 9.01% — down from 9.54% at the end of June and 11.22% at the end of May on the same measure.

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The magnitude of the monthly returns has continued to fall, however. In January and February, the ELLI gained 0.89% and 0.84%, respectively, while in April and May, the readings were 0.45% and 0.43%. By June, though, the monthly return had declined to 0.27%, and it fell further still in the latest reading.

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In addition, the market-value return ,which measures the movement in secondary prices for the index, dipped into negative territory for the second consecutive month in July at -0.17%, having been -0.04% in June. This is only the fourth time that the market-value return has been negative over the last 12 months, with this measure previously dipping into the red in October 2020 and then in March this year. The interest component returned 0.31% for July, up slightly from 0.30% in June.

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On a year-to-date basis, the market-value return stands at 0.93%, also behind the year-to-date interest return at 2.18%. But on a rolling 12-month basis, due to the dramatic appreciation in the index, the market-value return still beats the interest return at 5.03% to 3.99%, respectively.

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Single-B driver
For July, single-B credits, which account for the bulk of European transactions (roughly three-quarters of the ELLI), generated 0.19%, while the double-B cohort gained 0.03% and the triple-C category lost value at -0.08%. But over the last 12 months, the lower-rated asset classes continue to be a key driver of ELLI returns, with the single-B subset returning 8.51% and triple-C rated loans returning 23.38%, compared to 4.80% for the double-B grouping.

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The ELLI's year-to-date return stands at 3.11%, slightly ahead of June, when it was 2.96%. The weighted average bid of the ELLI has recently hovered around the pre-pandemic high recorded in January 2020 (it was 98.66 in that month), ending July slightly below that level at 98.63. A very full primary European leveraged loan market throughout July — whereby more credit selection was possible for investors and syndication processes often saw full allocations — left less demand in secondary, with new deals tending to limp out on the break. Any large falls in pricing did attract buyers quickly, however, keeping the average bid relatively stable throughout the month.

Even after overall trading volatility in the U.S. markets during the third week of the month, triggered by COVID-19 variant fears, the European loan market recovered quickly. The market did see a little softness, but this brought no more than a quarter- to half-point drop for most leveraged loan names amid relatively light trading flows. Decliners edged ahead of advancers for the month on 13 of the 22 days on LCD's measure, at a ratio of 2.87:1 on the days they outnumbered advancers.

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Although the weighted average bid of the ELLI has recovered to pre-pandemic levels, the pricing distribution of the index has not. Prior to the pandemic sell-off in March 2020, the share of facilities in the index priced at par and above was at a high of 59% at the end of January 2020. That same measure was only 8.8% at the end of July this year, having been 14% at the end of June. This bucket reached a pandemic-era high of 31% at the end of February 2021.

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The percentage of credits in the ELLI that are distressed — or those priced below 80 — has continued to stay low in recent months at only 0.37% in July, roughly in line with 0.39% in June, having been up at 29% at the end of March 2020. Defaults in the ELLI have also declined since the start of the pandemic. To the end of July, the index had a default rate of 2.52% by issuer count on a lagging 12-month basis, compared to a pandemic-era high of 4.84% in October 2020.

Small supply surplus
The European loan new issuance market has been healthy throughout the year, with total first-half leveraged loan volume coming in at €82 billion — a sum already higher than the full-year 2020 total of €64.9 billion and the highest first-half issuance since 2007 — with a big chunk of this supply coming from M&A activity. At the end of the second quarter, this backdrop resulted in the biggest supply surplus in Europe on a rolling-three-month basis since April 2020. To the end of July, this balance has stayed in surplus, but only just.

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Investments into loans — as measured by European CLO issuance — have outstripped available supply on a rolling three-month basis for the last eight out of 12 months, but this dynamic began to shift in July amid a surge of issuance. LCD calculates net supply by tracking new issues into the ELLI minus repayments, which worked out as €7.32 billion for the last three months, and with new CLO issuance coming in at €6.92 billion for the same time period, this leaves a small supply surplus of €400 million for the three months ended July, down from a surplus of 3.78 billion at the end of June. However, this figure does not take into account non-CLO funds in Europe, which also add to demand for the leveraged loan asset class — and indeed investors have told LCD that they have seen more inflows into these funds in recent months.

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Meanwhile, ELLI repayments rose sharply to €10.23 billion (4.07%) in July, from €2.85 billion (1.16%) in June. Chunky refinancings from issuers such as Nets, Vedici and Galileo Global Education helped to boost repayments nearly back to levels seen in May and April, of €11.23 billion (4.54%) and €11.44 billion (4.76%), respectively; note that April's figure was the highest monthly reading on this measure since the inception of the index. On a rolling three-month basis, this activity brings repayments to €24.31 billion.

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As for performance by asset class, European loans outperformed both U.S. loans and equities in July as the S&P/LSTA Leveraged Loan Index lost 0.01% in July, compared to the ELLI's 0.15% gain. The ICE BofAML Euro High Yield Index returned 0.40%, while European equities, as measured by the FTSE 100, lost 0.07%. Over the year-to-date, however, loans are running behind all the three other asset classes that LCD tracks on a monthly basis.

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* Article amended at 3:17 p.m. ET on Aug. 5, 2021, to restate the end-of-July default rate.