Year-to-date returns in the U.S. leveraged loan market entered positive territory last week, finally recouping staggering losses the $1.2 trillion asset class saw in March, as the coronavirus shut down economies around the globe.
The move back into the black for loans lags other broad asset classes — notably high yield bonds and investment grade debt — which saw direct or tacit support from the Federal Reserve after the pandemic's onset. Leveraged loans, which have seen intense scrutiny over the past few years from regulators and investors alike due to overall declining credit quality and aggressive deal structures, received no meaningful support from the Fed.
For the record, the YTD return for U.S. leveraged loans was 0.02% as of Sept. 16 (it slipped to negative 0.01% as of Sept. 18).
While it may have been difficult to foresee such a comeback, given the record severity of the declines that saw the market lose a whopping 12.37% in March alone, it is not altogether surprising, as the asset class has proved resilient over its 23-year history (per the S&P/LSTA Loan Index). Only once during that time has it finished with a full-year return figure in negative territory (2015).
The return to a positive YTD 2020 number from a negative 20.07% on March 23 is all the more impressive given the current climate of rising credit defaults and tightening lending standards, at a pace not seen since the Great Financial Crisis. And again, initiatives by the U.S. Federal Reserve to prop up capital markets were not nearly as supportive for leveraged loans as they were for other asset classes.
Nevertheless, the trough in loan prices certainly corresponds to the Fed's first program announcement, and loans have also benefited from other supportive technicals, including lagging new-issue volumes, versus 2019, and relatively strong investor demand, as evidenced by increasingly frequent issuer-friendly changes to loans that are in the syndications process (reflecting investor demand).
Comparing the loan market's performance to other asset classes, the change in value of $1,000 invested from the start of 2020 shows just how much loans lagged other risk markets in the recovery. The S&P 500 took a bigger hit in March, but the return to par was equally as dramatic, with this milestone reached as early as July, while high-yield bonds returned to face value in early August, closing out at a positive 0.75% YTD return by Aug. 31.
Digging deeper into those secondary market prices, the weighted average bid of the S&P/LSTA Loan Index climbed to 93.96 at the Sept. 16 close, its highest reading since March 8, and 17.7 points above the coronavirus-related low of 76.23 on March 23.
Looking even more closely, after a 38-day streak, through May 7, with no loans priced at par and above, 4.7% of outstanding loans have now topped this level. This compares to 52.9% at the end of 2019 and a 2019 average of 18%.
The share of loans bid below 80, at 5.1%, though significantly down from the 56.8% peak on March 23, remains elevated, compared to the 2019 average of 3.25%. That below-80 bid level is widely categorized as distressed debt. The current share in deep distress, below 70, at 2%, compares to a 2019 average of 1.5%.
Investors in the U.S. loan market today remain relatively discriminating when it comes to credit quality, though gaps in bid levels between better-quality and lesser-quality assets are narrowing. In general, the average bid of CCC+ rated loans (by issuer rating), at 83, represents a 10.7-point differential to loans from B- rated issuers, down from 15.81 points at the end of February. Dispersion among single-B credits has also declined, with the differential between single-B, and B-, at 2.96 points, down from an April high of 5.04 points; and single-B, versus B+, at 1.43 points, versus 2.69 points in April.
With the rise in average prices and narrowing quality-differential, the share of B rated issuer loans priced above 90 is fast catching up with BB issuer rated loans, according to the Index.
Bifurcation, of course, can also extend to industry segments. The following chart shows the development of the average bid of outstanding loans across various industries, at each month-end, and through Sept. 16. While the loan market sell-off in March was near-indiscriminate across the ratings scale, sector-based prices showed much more differentiation during the market rebound. At the end of 2019, all sectors priced within a 24-point range. By March this had widened to 39 points, with more industries gapping wider. Oil & Gas, falling to a 53.7 average bid, and Retail, falling to 69.7, drove much of this movement. In recent months, while average prices have risen, the differential has narrowed only six points, to 33.
On a final note, volatility in what historically has been a relatively stable U.S. loan market has, unsurprisingly, fallen significantly from its crisis peak. The rolling 30-day standard deviation of daily loan returns, which typically ranges from one to five basis points (with spikes over 20 bps extremely rare), skyrocketed to 165 bps in March. This measure has since retreated to seven basis points, and is now on a par with late-February levels.