It was an especially wild rollercoaster ride for the usually steady U.S. leveraged loan market in 2020.
The S&P/LSTA Leveraged Loan Index gained 0.77% in the first seven weeks of the year, followed by an unprecedented 20.7% loss in the four weeks from Feb. 23 through March 23, at the onset of the coronavirus pandemic. After hitting bottom on March 23, however, the $1.2 trillion asset class has climbed steadily, gaining almost 29%. As a result, loans posted a 3.12% return for 2020 overall — an impressive achievement considering that the market was in the red for most of the year.
Putting the market's 2020 performance into historical perspective: U.S. leveraged loans have gained an average of 5.55% per year since the inception of the index 24 years ago, with only two negative readings (down 29.1% in 2008 and 0.69% in 2015). While 2020's 3.12% return lags both the average and the median (5.03%) return, it is above the first quartile (1.99%), meaning that the 2020 loan market does not fall into the bottom 25% of historical returns over the last 24 years. This is notable considering the unprecedented turmoil and volatility of 2020.
Of course, the worst of the volatility that gripped the U.S. leveraged loan trading market — and risk assets broadly — during the depths of the March collapse eased in the second half of 2020, although it remained above 2019 levels. The standard deviation of the S&P/LSTA Index (measured on a 30-day rolling basis), a barometer of market volatility, stood at roughly 0.10% in the second half of 2020, slightly above its historical average of 0.09%, going back to April 2007. In 2019 this measure stood at 0.06%. For reference, the standard deviation of daily returns, per the index, skyrocketed to 1.67% on April 7, a notable level for what traditionally has been a less-volatile asset class, due in part to the segment's floating-rate structure and secured debt nature. The measure spent 31 days above 1% from March 18 through April 17, a level that was not topped even during the depths of the Great Recession.
By the end of 2020 the weighted average bid of loans underlying the index reached 96.19, gaining a hefty 162 basis points since the Pfizer Inc. vaccine news on Nov. 9, and almost 20 points since that figure bottomed out at 76.23 on March 23. The closing bid for 2020 was just 56 basis points short of the 96.75 level on Feb. 23, prior to the start of the sell-off.
While volatility has stabilized and prices have rallied, the growth of the loan market stalled last year, with the total par amount outstanding tracked by the S&P/LSTA Index hovering at roughly $1.2 trillion throughout 2020. The index expanded by less than 1% last year, the lowest growth rate in 10 years, down from 4% in 2019 and an M&A-fueled 20% in 2018.
Although the primary loan market finished the year on a strong note — fourth-quarter issuance was the highest since the first quarter — the tally for the year was the lowest since 2015. Moreover, issuance that backed buyouts and other M&A-related transactions dipped to $147 billion, an eight-year low, down 47% from the all-time high of $275 billion in 2018. As a result, issuance of new loans in 2020 simply covered repayments, leaving virtually no net new supply and keeping the size of the market unchanged.
December 2020 performance
The S&P/LSTA Leveraged Loan Index gained 1.35% last month, down from 2.23% in November, though a stronger gain than in October and September combined (0.84%). On average, loans gained 1.9% per month during the nine-month market rally, or 0.35% per month in 2020 overall.
Similar to November, the riskiest cohorts of issuers advanced more drastically last month, when looking at the average leveraged loan bid data, based on S&P Global Ratings' issuer rating. The average bid of issuers rated CCC+ rose to 88.26 in December, up roughly 2 points since the end of November and more than 5 points since the end of October. For reference, the average bid of this cohort climbed by almost 24 points since its intra-year low in March, at 64.47, and is now at the highest level since October 2018.
Similarly, the average bid of B- names rose by 135 bps in December, to 97.12, the highest month-end reading since October 2018. The average bid has gained more than 17 points since the end of March (79.74). At the same time, the average bid of B flat issuers advanced by 88 bps in December, to 98.40, while that of the BB- cohort gained 78 bps, to 99.03.
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 8.9 points last month, the lowest level since October 2018, compared to a 10 to 15 point range in the preceding nine months. The gap between B flat and B- loans shrank to 128 bps in December, a two-year low, compared to the recent high of 504 bps in April.
Looking at the 2020 loan market performance of the largest sectors (those with at least a 2% share in the index), three industries posted a loss — Leisure (down 5.33%), Oil & Gas (down 6.01%) and Retail (down 0.42%). Retail, which has faced strong headwinds from social distancing measures during the pandemic, managed to post a positive year-to-date return through Dec. 24 but ended the year in the red. On the flip side, defensive sectors led last year's outperformers, including Food Products (up 7.31%) and Drugs (up 6.86%). The two biggest sectors in the loan market — Healthcare and Technology — outperformed, each advancing some 5%.
By the end of December the bid distribution within the index moved closer to pre-COVID-19 levels, with the bulk of the names priced in the high 90s. Some 12% of loans within the index were priced at par or higher — the first time this share has reached double digits since the COVID-related sell-off in late February. However, the biggest slice of the index, at 40%, sat between 99 and just below par on Dec. 31, up from 25% in November and about 14% between August and October. Roughly 22% of the index names were priced in the 98 to 98.99 bucket, and another 14% sat between 95 and 98.
Loans priced below 80 — the traditional marker for distress — retreated to below pre-COVID levels, at 2.2% of performing loans, the lowest reading since February 2019. Recall that this reading reached its COVID-era peak of 57% on March 23. Since that time the distress ratio has consistently declined, falling below 10% in the second half of 2020.
In December, 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 $8.1 billion in December, the biggest expansion in four months, bringing the total par amount outstanding to $1.204 trillion. However, for the year overall, the index grew by just $6 billion, or less than 1%. For comparison, the index expanded by $47.7 billion in 2019, or roughly 4%. In fact, the total par amount outstanding has remained at roughly $1.2 trillion for the last 14 months, as new issuance of leveraged loans offset repayments, but did not generate much net supply.
The market grew in December as M&A activity picked up late in the year, including a $2.575 billion term loan for Inspire Brands Inc. to fund the acquisition of Dunkin' Brands Group Inc. and a $1.6 billion term loan to finance The Blackstone Group Inc.'s acquisition of Ancestry.com LLC. Ten new loans of more than $1 billion joined the index in December, although some financed a recapitalization or a refinancing, meaning they did not represent net new supply entirely.
Refinancing activity helped propel the repayments of leveraged loans to $30.5 billion in December, almost double the November total ($15.9 billion), and the second-highest reading in 10 months (behind $33 billion in October). Nearly half of the $30.5 billion stemmed from refinancings for issuers such as Asurion LLC and Calpine Corp. For the fourth quarter overall, $79.5 billion of loans were repaid, the most since the third quarter of 2019 ($88.9 billion) and up from $38.3 billion in third quarter 2020 and just $29.1 billion in second quarter 2020, which was the lowest level in over five years.
Turning to demand: The U.S. CLO market finished the year with a healthy $9.8 billion issued in December, from 23 vehicles, far ahead of the monthly average during a difficult 2020 ($7.7 billion/12 vehicles). The final three months of the year were the strongest quarter for supply in 2020, at $30.8 billion, or 33% of the full-year total ($92.1 billion). Despite the robust finish, 2020 will not go down in the annals as a strong one for supply. It is the second-worst year since the start of 2016.
At the same time, U.S. retail funds investing in leveraged loans saw inflows totaling $516 million in the five weeks through Dec. 30, according to Lipper weekly reporters. This was not only the first month registering an inflow since January but the highest such inflow since September 2018. In addition, retail funds saw four consecutive weeks of inflows last month, something that has not happened since October 2018. However, in 2020, cash redemptions at these funds and exchange-traded funds totaled $19 billion, on top of the $27.7 billion withdrawn from the asset class during all of 2019.
More broadly, LCD estimates $727 million of inflows into retail loan funds in December, versus $521 million of redemptions in November. The net effect of this increase in retail loan fund investments, and an increase in CLO issuance (to $9.8 billion), resulted in an increase to total investor demand last month, at $10.5 billion, from $6.9 billion in November. Combining the $8.1 billion increase in outstandings — the proxy for supply — with $10.5 billion of measurable demand leaves the market with a $2.4 billion supply shortage. This is a more balanced picture than just two months ago. October's shortage stood at nearly $20 billion. For the fourth quarter, measurable demand exceeded supply to the tune of $28.9 billion, and for all of 2020 this measure totaled $58.2 billion.
Other asset classes
With a 1.35% gain in December, U.S. loans outperformed 10-year Treasurys and high-grade bonds but underperformed high-yield bonds and equities. However, for the year overall, loans landed at the bottom of the pack among asset classes LCD tracks for this analysis. This is the second consecutive year loans have underperformed. 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.
Among the top advancers in the relatively quiet last month of the loan market year were a number of CCC rated issuers, which again outperformed as a ratings group, for the fifth straight month, relative to the higher rated components of the S&P/LSTA Index. Of the top 10 biggest gainers in December, five were in the CCC category and included Audio Visual Services Corp., Envision Healthcare Corp., Anastasia Beverly Hills Inc., Syniverse Technologies LLC and TKC HOLDINGS, Inc. Despite a continued negative outlook for the airline industry, airline operator American Airlines Group Inc. topped the list of advancers.
Moving the other way, a pair of movie theater operators topped the list of decliners in December as coronavirus restrictions continue to wreak havoc on the industry. Cineworld Group PLC and AMC Entertainment Inc. each moved lower. AMC Entertainment was downgraded by S&P Global Ratings to CC on Dec. 16, with a negative outlook, as the company announced a private transaction to inject $100 million in cash into the company via new debt, and also announced a debt-for-equity swap. The company also filed a Form S-3 on Dec. 29 to offer another 50 million shares of its class A common stock for sale, following an earlier announcement of a larger stock sale.