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US leveraged loan returns soar in November on vaccine hopes, led by riskier debt

The U.S. leveraged loan secondary market mounted an impressive rally in November amid positive news regarding a coronavirus vaccine.

The S&P/LSTA Leveraged Loan Index gained 2.23% last month, a six-month high, including a 0.70% gain on Nov. 9 alone, its largest daily return in seven months. To underscore the magnitude of the vaccine-related rally: On Nov. 9, loan advancers outnumbered decliners 22 to one, the highest ratio since at least the start of 2017.

As a result, the year-to-date return for the $1.2 trillion asset class has stepped back into the black, in a decisive fashion, after hovering around zero for two months, with loans up 1.76% in 2020, through Nov. 30.

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November's strong return resulted from big gains from industries that have been hardest hit by the impact of COVID-19 and credits at the lower end of the quality spectrum. Looking at returns by S&P facility-level rating, loans in the triple-C ratings bucket (CCC+, CCC, CCC-) gained 6.28% in November, after receiving a major boost following news of vaccine progress. That monthly return was the highest reading in 11 years, since the 7.37% return in September 2009.

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More importantly, the market value component of return, which captures only the increase or decrease in secondary market prices, was 5.73% for the CCC sub-index, the highest since September 2009, when it rose 6.81%. For the year overall, triple-C's remain in the red based on market value, down 5.03%, which includes a massive 22.87% loss in March. However, based on total return, which includes the interest component, they are up 1.97%.

While the higher-rated constituents of the index also saw a notable bump in secondary prices on Nov. 9, it was less drastic than for the riskiest loans. Loans in the single-B ratings bucket gained 2.05% in November, based on total return, outperforming double-B loans sub-index, which was up 1.67%, although both cohorts posted the highest gains in four months. However, for the year overall, the higher-rated double-B sub-index remains in the red, down 0.34%, while its lower-rated single-B counterpart has gained 2.36% through Nov. 30.

A similar picture emerges when looking at sector performance last month, as industries most affected by the social distancing measures during the pandemic rallied more strongly on the vaccine news. Loans from the Leisure sector topped the leader board last month, rising 5.67%, the highest monthly reading for this sector since the end of the Great Financial Crisis. This follows two months of losses for Leisure loans, totaling close to 2%, amid a rising number of COVID-19 cases globally.

November's gains reduced the year-to-date loss for Leisure loans to 5.80%, from 10.85% at the end of October. However, it remains the second-worst performer on a year-to-date basis, behind Oil & Gas, when looking at the largest sectors in the loan market (those with at least 2% share based on outstandings).

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Similarly, Lodging/Casino loan issues gained 3.04% in November, a six-month high, bringing the year-to-date return for that segment out of the red for the first time since the onset of the pandemic, up 0.82%. Oil & Gas was up 3.49% in November, a five-month high, after posting a monthly loss in October for the first time since the March sell-off. Nonetheless, this sector remains at the bottom of the pack for the year, down 8.84%.

Returning to the overall secondary market, U.S. loan prices advanced by 194 bps in November, including a 65 bps bump on Nov. 9 alone, to close out the month at 95.11, the highest reading since March 4. The average is still almost two points short of the 96.75 level on Feb. 23, prior to the start of the sell-off.

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Looking at the average leveraged loan bid data, based on S&P Global issuer rating, the riskiest cohorts of issuers advanced more drastically in November. The average bid of issuers rated CCC+ rose to 86.22 by the end of the month, up 332 bps from the end-of-October reading and the highest level since November 2018 (87.88). For reference, the average bid of this cohort has climbed by roughly 22 points since its intra-year low in March, at 64.47. The pace of downgrades continued to slow in November, leaving the CCC+ share of the Index at roughly 7% since May, although that's up from 2.8% at the end of 2019.

Similarly, the average bid of B- names rose by 197 bps in November, to 95.77, the highest month-end reading since July 2019, at 95.98. The average bid has gained more than 16 points since the end of March (79.74). The share of B- rated leveraged loan outstandings has also remained relatively stable since May, at around 23% of the Index, as these loans have taken up a record share of the new-issue market in 2020. At the same time, the average bid of BB- rated issuers advanced by 102 bps in November, to 98.25, while that of the BB flat cohort gained 81 bps, to 98.41.

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In addition, the gap between the higher-rated and lower-rated names continued to shrink. The difference in the average bid of the B- and CCC+ cohorts fell to 10 points last month, a two-year low, compared to an 11-15 point range in the preceding eight months. The gap between B flat and B- loans shrank to 175 bps, the lowest reading since August 2019, compared to the recent high of 504 bps in April.

Price distribution
By the end of November, 27% of loans within the index were priced between 98 and 99, while another 25% was priced between 99 and below par. For both buckets combined, it was the highest share since the end of February. The share of loans priced at par or higher jumped to 3.7% by month-end, its highest reading in seven months.

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Loans priced below 80 — the traditional marker for distress — account for 2.8% of performing loans, down from 4.9% in October. Recall that this reading reached its post-coronavirus-onset peak of 57% on March 23. The current level is now below the 5.9% level of one year ago but above 1.8% two years ago.

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Technical talk
In November, the supply/demand dynamics in the U.S. leveraged loan market resulted in a net supply shortage. Supply is measured as the net change in outstandings, per the S&P/LSTA Index. LCD defines investor demand as CLO issuance, combined with retail loan fund flows.

Starting with supply: The par amount outstanding tracked by the Index grew by $1.2 billion in November, after shrinking by nearly $11 billion in September and October combined. For the year overall, the Index has compressed by $1.8 billion. For comparison, the Index expanded by $48.2 billion during the same time last year. In fact, the total par amount outstanding has remained at roughly $1.2 trillion for the last 13 months, as new issuance of leveraged loans offset repayments but generated little net supply.

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New-issue volume: There was $18.6 billion launched in November, down from $33.1 billion in October, although 60% of that activity stemmed from M&A transactions, versus 52% in October. Repayments declined as well — to $15.9 billion from $33 billion in October—the net result of this activity was a small expansion to the total amount outstanding tracked by the index.

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Turning to demand: CLO issuance stepped back in November, to $7.4 billion, from $12.8 billion in October and $11.5 billion in September, the two busiest months of the year for such activity. On average, CLO creation has totaled $7.3 billion a month in 2020, a slower pace than $9.9 billion monthly average in 2019. As a result, year-to-date issuance of $80.7 billion is 27% below the same time last year, at $110 billion, although the gap is down from 33% at the end of the third quarter.

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At the same time, U.S. retail funds investing in leveraged loans withdrew another $370 million from the asset class in the four weeks through Nov. 25, according to Lipper weekly reporters. Withdrawals averaged $92.5 million per week last month, up from $63.5 million per week in October but below $235 million in September. For the year to date, redemptions total $19.6 billion, on top of the $27.7 billion withdrawn from the asset class during all of 2019.

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More broadly, LCD estimates $521 million of outflows from retail loan funds in November, up from $358 billion of redemptions in October. The net effect of this increase in retail loan fund withdrawals, and a decrease in CLO issuance (to $7.4 billion), resulted in a decrease to total investor demand last month, at $6.9 billion, a three-month low. Combining the $1.2 billion increase in outstandings—the proxy for supply—with $6.9 billion of measurable demand leaves the market with a $5.7 billion supply shortage. For reference, October's shortage stood at nearly $20 billion. For the last three months, measurable demand exceeds supply to the tune of $38.9 billion, and for the year through Nov. 30 this measure totals $53.9 billion.

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Other asset classes
With a 2.23% gain in November, U.S. loans outperformed 10-year Treasurys but underperformed all other asset classes LCD tracks for this analysis. Equities led in November and for the year overall, as the S&P 500 gained 10.95% last month and 14.02% for the year to date. Although loan cumulative return has finally turned positive for the year, loans remained at the bottom of the pack based on the asset classes LCD tracks for this analysis. Should this relationship hold true through December, this will be the second consecutive year loans have underperformed. For reference, in the 23 years between the inception of the S&P/LSTA Loan Index and 2019, loans landed at the bottom of the pack just five times.

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Biggest movers
It is no surprise that the top advancers in the strong secondary market in November included a number of those CCC rated issuers. Near the top of the list in November was Cineworld, after being a top decliner the past two months. Some 10 days ago the global cinema chain began a process to renegotiate property leases while securing $450 million in liquidity financing shortly thereafter. The company was downgraded to SD by S&P Global Ratings last week, as the rating agency views its new $450 million secured term loan as a distressed transaction. Also among the triple-C issuers that made the list of top advancers in November were Envision Healthcare, Travelport, AMC Entertainment Holdings Inc., and Audio Visual Services Corp.

Moving the other way, J.C. Penney topped the list of decliners as the company continues to move through its bankruptcy. The company's reorganization plan received confirmation from the court overseeing its Chapter 11 proceedings on Nov. 24. Also on the list of the biggest decliners in November were a handful of other defaulted issuers, including Fieldwood Energy, Alamo Portfolio, and Libbey Glass.

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