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Riskier leveraged loans outperform as investor reach for yield continues

With strong buyside demand in the U.S. leveraged loan trading market to start the year, investors have been left searching for yield, sending returns on the risky, triple-C rated portion of the S&P/LSTA Leveraged Loan Index soaring in the first three weeks of 2021. The CCC rated portion of the index returned 3.30% in the year through Jan. 22, compared to just 1.25% and 0.99% for the single-B and double-B rated cohorts, respectively. The rated subsets of the S&P/LSTA Leveraged Loan Index represent facility-level ratings.

With the average bid on the BB rated index and the single B index nearing par and quickly converging, at 99.73 and 99.35, respectively, and Libor under 25 basis points, the yield to maturity on the respective indices has dropped to all-time lows, to just 3.14% and 4.52%, respectively. This has left investors in the asset class with few alternatives but to turn to the lower-rated debt. As of the end of December, 39.7% of the loans in the overall index had Libor floors of more than 0%, with an average floor at 95 basis points.

With a Libor floor, a predetermined spread kicks in should actual Libor drop below a specified level.

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The average bid of the triple-C portion of the index rose to 89.68 on Jan. 22, gaining more than two points from the 87.10 level at year-end 2020 and rallying from a low point of 62.71 amid the height of the market turmoil in March 2020. The average bid of the triple-C index is at its highest level since it reached 89.79 on Nov. 12, 2018, while the yield to maturity on Jan. 22, at 8.73%, was at its lowest level since September 2014.

The CCC loans have been further buoyed by a diminishing supply of higher-rated counterparts to choose from. The amount of BB rated loans outstanding in the S&P/LSTA Leveraged Loan Index has shrunk to $247.6 billion as of Jan. 22, from $256.7 billion as recently as Dec. 10, 2020, and from $288.2 billion at the start of 2020.

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The surge in the triple-C portion of the index comes as the overall S&P/LSTA Leveraged Loan Index has climbed back to pre-pandemic levels. The share of loans in the index priced at par or above surged to 44.6% as of Jan. 22, its highest level since Feb 3, 2020, and up from 12.5% on Dec. 31, 2020. Additionally, the average bid of the overall index is now at 97.44, its highest mark since it briefly breached that level for a few days in May 2019. Prior to that, it hadn't been this high since November 2018.

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The recent strength in the secondary comes as investors have piled into loans in 2021, reflecting strong demand for the floating-rate asset class. U.S. loan funds have seen a net inflow of approximately $2.46 billion through Jan. 20, with the $1.37 billion net inflow for the week ended Jan. 20 the largest weekly gain for the asset class since the week ended Dec. 21, 2016. The heavy inflows stand in stark contrast to 2020, in which loan funds saw outflows of roughly $19 billion, as investors showed preference for fixed-rate high-yield bonds.

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