| NEW YORK, Sept 30
NEW YORK, Sept 30 A recent influx of retail
investors into the US leveraged loan market, driven by the
prospect of near-term interest rate hikes and rising Libor
rates, is helping to push secondary prices higher as loans
continue to offer good relative value compared to high-yield
Retail investors, individuals who invest via bank loan funds
rather than institutional investors such as pension funds and
endowments, have been targeting the US leveraged loan market
since August as signs indicate that the Federal Reserve is
intending to raise interest rates.
This has prompted nine weeks of inflows into the asset
class, which continues to offer good yields as returns in other
products grind lower in a volatile environment driven by
political considerations and macroeconomic concerns.
This is the longest stretch of loan inflows into bank loan
mutual funds since a 95-week inflow ended in April 2014 as a
rate rise grew less likely. The influx of cash, however, is
exacerbating a lack of supply in the primary market and driving
secondary prices higher.
Average bids in the overall secondary market climbed to
96.96 on September 28 to its highest level since October 2,
2015, and the SMi100, which tracks the 100 most widely held
loans, rose to 99.09 on September 28, according to LSTA/Thomson
Reuters LPC Mark-to-Market Pricing.
"It's the combination of Libor rising and expectations that
the Fed is signalling a rate increase at the end of the year.
Generally, that makes investors more focused on floating rate
assets overall, and loans in particular," said Steven Oh, global
head of credit and fixed income at PineBridge.
FLOATING RATE HEDGE
Retail investors often use floating rate loans - which pay a
spread over Libor - to hedge portfolios against rising interest
rates. Although the Federal Reserve kept the federal funds rate
steady last week, many expect it to rise in December.
The recent spike in the Libor rate - the rate banks charge
each other for short-term loans - is also boosting retail
appetite. Three month Libor hit a seven-year high of 87bp on
September 20, boosted by the implementation of the SEC's looming
implementation of money market reforms on October 14 and the
dollar funding needs of non-US banks.
Three-month Libor of 84bp on September 28 is still
significantly higher than 33bp a year ago and has pushed a
swathe of leveraged loans with Libor floors of 75bp or sub-Libor
floors into paying floating rates again.
Libor floors, which guarantee returns for investors,
initially limited the benefits of rising Libor for investors,
but Libor is now sufficiently high that investors holding loans
with 1% Libor floor expect to be paid a spread over the
"While Libor should come down some in the fall Libor levels
are still likely to be higher on a sustained basis, as money
market reform will reduce the amount of funds available to these
banks for quite some time. Bank loan funds are likely to be a
potential beneficiary of this change," said OppenheimerFunds in
a July report.
Leveraged loans are also looking attractive against
high-yield bonds, which are trading lower after peaking on
September 8, according to the Merrill Lynch High Yield Master II
Leveraged loans have returned 7.7% so far this year,
according to the S&P/LSTA Leveraged Loan Index, compared to
14.9% for bonds. High yield bonds' superior performance this
year has left junk bond and loan spreads at nearly the same
level, according to S&P/LSTA and Barclays US High Yield Bond
As loans are senior and secured with higher historical
recovery rates than bonds, this promises better future returns
on loans, sources said.
"The relative value is in favor of loans right now," a loan
and bond investor said.
MORE INFLOWS EXPECTED
Retail investors new-found enthusiasm for leveraged loans is
expected to funnel more cash into the asset class. Investment is
already accelerating - September saw US$1.4bn of inflows, up
from US$281m in August. This brings third quarter inflows to
US$2.2bn in the first positive quarter for inflows since the
first quarter of 2014.
This cash is intensifying the supply-demand imbalance that
has characterized the leveraged loan market for most of this
year. Retail investors will be competing for assets with
US$1.7bn of new Collateralized Loan Obligation (CLO) funds that
were issued in September along with separately managed accounts.
"CLOs, retail investors, institutional buyers - everybody
wants leveraged loans," a loan investor said. "That means higher
(Reporting by Lisa Lee; Editing By Michelle Sierra and Tessa