October 7, 2020 - The September secondary loan market turned out to be a glass half-filled (more on that later).  Although returns on the S&P/LSTA Leveraged Loan Index remained positive in September, at 0.63%, it was the weakest performance recorded during the six month recovery that began in April.  That is because September was truly a tale of two halves –not just for loans, but for all risk assets.  Across the first two weeks of the month, the secondary loan market was in full-on rally mode as average bid levels improved for 11 straight trading sessions.  Over the eleven-day period, bids climbed more than 100 basis points in the secondary, and year-to-date loan returns moved back into the black for the first time since January.  And we cheered, as the market climbed back into positive territory after being down more than 13% at the end of the first quarter.  But the cheering proved to be short-lived, as the broader markets pulled back during the second half of September.  While the loan market went on to give up roughly half its gains during the two-week sell off, it still turned out to be the best performing asset class in September – something we haven’t reported since February.  That said, loan returns still trail that of each of the other major asset classes in the year-to-date category at negative 0.66%. (We would note that high yield bonds remain in the red on the year as well.)

Despite the countless uncertainties surrounding the future ramifications of the COVID-19 pandemic, the loan market has been resilient over the past six months.  After producing a 9.8% return during the second quarter, the loan market tacked on another 4.1% return during the third quarter.  And while September marked the weakest performance since March, bids still improved an additional 33 basis points on an advancer/decliner ratio of 1.8:1.  In total, the market’s average bid has rallied more than 16 points off its March lows, and now sits north of a 93, off roughly 400 basis points from its pre-COVID-19 high.  At the same time, bid-ask spreads tightened just 14 basis points in September. At 157 basis points, the bid-ask spread is 270 basis points tighter than its March wides, but still 50 basis points wider than January tights. 

And of course, there have been sector winners and losers across 2020 as the pandemic has brought a slew of industry specific challenges and a few opportunities.  Most affected to the downside has been the Oil & Gas sector, which is down 11.6%.  Next up is Leisure at negative 9.8% and Retail, which is down 4% on the year after a significant rally over the past few months.  On the “opportunity” side, the food product sector is this year’s industry stalwart at 4.5%, followed by the drug sector, which sports a 3.6% return on the year.  Finally, let’s get back to the “glass half full” argument.  First, despite a default rate that now sits above 4% and is expected to breach 5% by year’s end, the rate of downgrades (and defaults) has been declining at an increasing rate.  Second, as noted last month in this space, the CLO engine is revving up again as more than $10B worth of deals printed in September (a 2020 high).  At the same time, loan mutual fund flows, while still negative in September at $600M, have steadily improved since March.