The leveraged loan market was hotter than the weather in August. After returning 1.16% in July, the S&P/LSTA Leveraged Loan Index gained 1.12% in August, bolstered by strong technical conditions and a supportive macro environment. Meanwhile, the large-cap loans that comprise the S&P/LSTA Loan 100 returned 1.28% as investors bid up beaten-down high-beta names.
The S&P/LSTA Index has returned 6.94% in the year to date, while the Loan 100 has led the way with a 7.91% gain.
With the markets running hot, lower-rated paper outperformed in August. In part, these gains at the low end of the grade reflect bargain-hunting by relative-value investors flush with capital. Fundamental factors were also at work here, as several large, high-beta issuers took advantage of robust liquidity in the credit markets to shore up their balance sheets. Examples include:
- Bond refinancings for TXU, Univision, and Caesars;
- A loan refinancing for Supervalu;
- Extensions for First Data and Caesars.
August’s benign macro environment lifted all risk assets, including loans. For one thing, there was no traumatic flare-up in the ongoing eurozone debt crisis. For another, U.S. economic reports, though hardly ebullient, were generally in line with expectations. The Federal Reserve beige book, for instance, indicated that the economy expanded gradually in July and early August as growth in retail and housing offset weakness in manufacturing.
The S&P 500 rallied 2.25% in August, illustrating the positive bias in the capital markets.
Closer to home, the loan market’s own strong technical conditions helped drive up prices. On the demand side, regular-way CLO issuance soared to $4.8 billion, from $1.8 billion in July. And inflows to loan mutual funds continued, at $449 million, according to EPFR, after a $596 million infusion in July.
In addition to these visible inflows, demand was also propped up by (1) allocations from pension funds and other institutional investors, which managers say continued apace, and (2) a strong undercurrent of loan demand from high-yield mutual funds, which took in $2.8 billion in August, according to EPFR.
Another boost to demand was a surge in high-yield takeout activity, which, on a pro forma basis, reached a two-year high of $5.1 billion (including bonds that printed but have yet to fund and repay loans).
The same combination of muscular inflows and takeout activity that elevated secondary prices in August also weighed on primary clearing yields, which narrowed to their lowest level since March.
With the new-issue engine humming, arrangers and issuers kept their foot firmly on the pedal. Indeed, arrangers inked $16.3 billion of new loans during the month, including $11.4 billion of institutional tranches, making it the busiest August on record by both measures.
Looking ahead, market players expect loan prices to stabilize in September as arrangers bring out what promises to be wellspring of new leveraged finance paper. In fact, arrangers say the calendar of high-yield and leveraged loans stood at a robust $55-60 billion at the end of August.
This amount includes a number of large deals in the queue, such as AOT Bedding, Getty Images, Genesee & Wyoming, Par Pharmaceutical, Syniverse, Hamilton Sunstrand, and DuPont’s performance-coatings unit. Together, these deals could bring as much as $8-10 billion to the institutional loan market. Also, sellside bankers say screening activity has been strong all through the summer, suggesting that more M&A-driven deals are likely to be added to this list.
Managers are hopeful that the expected burst of M&A deal flow will support fund-raising efforts by pushing up new-issue and secondary loan yields – or at least keeping them from falling further – and creating a ready source of paper with which to ramp new CLOs.
Of course, there are many risks to this upbeat forecast, such as the outcome of the U.S. election, the eurozone’s ever-present fragility, the U.S. fiscal cliff, and the potential for a hard landing in China.
Index reaches a new high in August
With August in the books, the S&P/LSTA Index stands at a record 2,242.
Subtracting the interest component of returns, the market-value component of the Index pushed to a 13-month high of 843 in August.
Loans versus other asset classes
With the capital markets rallying in August and the benchmark 10-year Treasury yield inching up to 1.63% on Aug. 30, from 1.51% at the end of July, loans lagged equities and high-yield bonds but outperformed corporate bonds and Treasuries.
Likewise, in the year to date loans lead only 10-year Treasuries among the five asset classes we track in this monthly report.
On a risk-adjusted-return basis, meanwhile, loans continue to lag all but equities since the commencement date of the S&P/LSTA Index in January 1997.
Of course, fixed-income assets have seen a titanic bull run over this nearly 15-year period, with the 10-year Treasury yield falling to just 1.63%, from 6.93% at the end of 1996.
In August, the Index was led higher by TXU and Clear Channel, two large CCC names that have long traded at discounted levels. Clear Channel rallied after the issuer reported better-than-expected second-quarter results, while TXU rose after the issuer tapped the bond market for a $1.75 billion, two-part offering, proceeds of which are set to repay demand notes. Supervalu, First Data, Caesars, and Univision also gained after the issuers executed maturity-extending transactions.
Meanwhile, the largest detractors from Index returns in August were loans that moved on specific news, though they shaved overall returns only slightly.