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NEW YORK, Jan 10 (Reuters) - Loan traders expect a strong technical market and excess demand to support high secondary prices in early 2017 as fears of further rate rises funnel more cash into the asset class and traders focus on sectors that could benefit under the Trump administration.
Average secondary bids rose to 98.09 on January 9, after climbing 2.8bp in 2016 in the biggest annual rise since 2012 and from a four-year low of 94.4 in February, according to LSTA/Thomson Reuters LPC MTM Pricing.
"We are on fire. It's hard to see what will change until further notice," a loan trader said.
Secondary prices rallied strongly in 2016 and returns soared to 10.16%, boosted by the oil price recovery. With 45.8% of loans trading over face value or par on January 5, compared to only 1.57% at the end of 2015, this performance will be harder to match this year, traders said.
Investors struggled to find deals in the primary market last year, which inflated secondary prices, caused downward pressure on primary pricing and prompted a wave of repricings.
Demand is expected to stay high this year. Cash continues to flow into the asset class as investors buy floating rate loans to hedge against the three possible interest rate rises that the Federal Reserve is flagging. Most US leveraged loans are now floating rate after 3-month Libor hit 1.005% on January 4, exceeding a 1% Libor floor cap rate on most loans.
Bank loan mutual funds have seen strong inflows since August, according to Thomson Reuters Lipper, with four weeks of inflows topping US$1bn since November 8, after Donald Trump's US election win, bringing the total for 2016 to US$6.7bn.
In December, US$7.28bn of new CLO funds were issued, after US$10.6bn in October, bringing the annual total to US$72.4bn and institutional investors are continuing to stream cash into separately managed accounts, sources said.
"Investors are using the loan asset class for what it's been known for: a hedge against rising rates and inflation. Credit is likely to perform well and investors are still hungry for yield," said Jonathan Insull, a portfolio manager at Crescent Capital Group.
Investor demand is so strong that even loan repricings, which cut coupons and returns and typically trade at lower levels, are failing to put a brake on secondary prices. Several deals have traded as high as 101 in recent weeks.
Rubber producer Kraton Polymers LLC's US$1.278bn term loan traded at 101.25-101.75 in mid-December and remained at 101.125-101.625 in early January after cutting the spread by 100bp to 400bp over Libor with a 1% floor.
Cloud services company Rackspace Hosting's US$2bn term loan broke at 100.625-101.125 in mid-December and rose to trade at 101.25-101.625 in January after shaving pricing by 50bp to 350bp over Libor with a 1% floor.
"Perhaps if supply increases that may impact secondary prices. Until then loans can trade at least 50bp above par, until repricings happen, even then we are seeing repriced loans trade right back up," a loan trader said.
Traders are focusing on sectors that may benefit under the new Trump administration that previously struggled with regulation or political scrutiny including pharmaceuticals, which were criticized on pricing by Democratic nominee Hillary Clinton, and utilities, sources said.
Average bids in the healthcare sector were 98.26 on January 9, up from 97.68 on November 9 immediately after the US election result. Pharmaceutical company Valeant's term debt has climbed since Trump's election win, gaining more than a point to 100-100.5 on January 9. Drug firm Mallinckrodt's term loan added also almost a point to trade at 100.25-100.75 in early January.
Average bids in the utility sector have climbed to 97.02 from 96.16 since Trump's election. Power company Calpine's repriced term loans traded above par on the break in December and power company Lightstone Generation's new US$1.575bn term loan B and US$150m term loan C traded at 99.5-100.5 in December.
Other sectors may be less favored, including hospital companies such as Community Health Systems if the Affordable Care Act is overturned, sources said. The term loans of defence companies could also tumble if Trump continues to protest about their bills to the government.
The retail sector also remains an area of concern, particularly clothing retailers and specialty item vendors, as consumers continue to move to online shopping and make lifestyle changes.
Apparel retailer J Crew's term loan has tumbled more than 23 points from early October to 54-57 on January 9. Children clothing retailer Gymboree's term loan has sunk nearly 28 points in the same time to 51-53 in January. And high-end department store Neiman Marcus' term loan dipped nearly 6 points in three months to 86.25-87.25 in January. (Reporting by Tessa Walsh and Lisa Lee; Editing By Michelle Sierra and Jon Methven)