NEW YORK, May 4 (LPC) - The US leveraged loan market hit a milestone of US$1trn in assets amid a standout performance further boosting investor demand for floating-rate debt.
Leveraged loans posted a 1.5% return in the first quarter of 2018, outperforming negative returns in equities, investment-grade bonds and high-yield bonds, according to S&P/LSTA Leveraged Loan Index and Bank of America Merrill Lynch Indices.
This positive performance is driving up secondary pricing, pushing trading volume higher, as demand for floating-rate paper in a rising interest rate environment attracted US$1.56bn of new money into loan mutual funds in April alone, according to Lipper. Historically, loans outperform other fixed-income instruments in a rising-rate environment.
The S&P/LSTA Leveraged Loan Index, which represents the overall loan market, hit a record US$1trn in loans outstanding on April 27, taking the US leveraged loan market close to its nearest point to high-yield bond outstandings of US$1.1trn, with ‘only’ a US$100bn gap.
“The (loan) market has grown substantially since the end of the financial crisis,” said Joseph Lynch, portfolio manager for non-investment grade credit at Neuberger Berman. “Most of the issuance recently has been refinancings, and we have also seen a pickup in M&A activity this year on the back of the tax law changes.”
The market’s near doubling from US$550bn in 2013 is all the more remarkable as a wall of regulation was introduced at that time to curb the market’s excesses and growth, and cap systemic risks for banks.
This growth mirrors the rapid development and diversification of the institutional buyside, which filled the gap as banks stepped back amid increased regulation. A record US$923.8bn of US institutional loans was issued last year.
This was supported by US$117bn of demand from Collateralized Loan Obligation (CLO) funds and US$12.5bn of inflows into loan mutual funds, according to Thomson Reuters LPC Collateral and Lipper data.
“The growth in the loan market has come as a result of increasing demand from institutional investors, and increasing supply from small first-time issuers,” Neha Khoda and Oleg Melentyev, BAML credit strategists, wrote in a May 2 research report.
The benign credit environment and strong fundamentals are expected to continue to support the loan market going forward as investor demand shows no signs of slacking.
“As we move forward, the backdrop looks good,” said Ted Basta, executive vice president of market analytics and investor strategy at the Loan Syndications and Trading Association (LSTA). “We are in a rising-rate environment and fundamentals look good. The current earnings season has been pretty good and default rates are low.”
US secondary trading volume increased 10% to US$164bn in the first quarter, according to the LSTA. Average trade prices hit 100.25, and the average bid-ask spread tightened to a post-credit crisis low of just 48bp.
“People are bidding up prices,” said Kimberly Flynn, managing director of alternative investments at XA Investments. “You will see additional interest in senior loans with the strong performance in the first quarter. There will be a wave of interest as advisers look to shift their portfolios.”
On average, 451 loans traded daily in the last 12 months, totaling US$2.6bn per day, according to the LSTA. Only 5% of loans traded below 90 in the first quarter, down from 10% in the fourth quarter, and 61% of loans traded above par, up from 51% in the fourth quarter, the trade association said.
The average loan trade price is “certainly on the higher side, but definitely not a peak level,” Lynch said. “The market could trade up from here. It’s just a reflection of solid underlying fundamentals and strong demand for loans.”
Even loan repricing deals, which cut spreads and typically trader lower, are seeing strong demand and trading up to around 101, which highlights unsatisfied demand and could continue to put pressure on primary pricing.
Hilton Worldwide’s US$3.4bn repriced term loan B opened in the secondary market at 100.75-101 on April 12 after cutting the spread by 25bp to 175bp over Libor with a 0% floor. It traded slightly up at 100.875-101.25 on May 2.
Wells Enterprises, a privately held, family-owned ice cream and frozen treat manufacturer, also repriced a US$175m term loan in mid-March. It broke in the secondary market at 101-101.5 on March 22, and was quoted at 101.25-102.25 on May 2.
Additional reporting by Kristen Haunss. Reporting by Yun Li Editing by Tessa Walsh