Monday, February 25, 2013

Leveraged loan market on fire

Sub-investment-grade loans continue to perform well, driven by demand for floating rate product. As an example, the chart below compares the performance of Invesco's "Senior Income" fund (VVR) - which mostly holds loans of non-investment-grade companies - with HYG (iShares junk bond ETF) and an S&P500 ETF.

Source: Ycharts (click to enlarge)

Capital continues to flow into this asset class at record levels.
JPMorgan: - Leveraged loan funds had another record inflow, totaling +$1.42bn for the week (2.90% of AUM), following previous record-high inflow totaling +$1.20bn the prior week (2.52% of AUM). This marked the 35th consecutive inflow for loan funds, and the breakdown of this week’s flows was a +$179mn inflow into the ETF (13%) and an inflow totaling $1.24bn into actively managed funds (87%). For context, there have only been two other $1bn+ weekly inflows reported for loans, with those being December 22nd 2010 and February 9th 2011. Overall, the past four weeks’ inflows are the largest for the asset class since 1Q11, a period when interest rate pressure was elevated in the wake of QE2 and growth expectations were robust.
Indeed the demand for senior corporate loans of leveraged firms (otherwise known as "bank loans" because each is structured as a loan provided by a bank) is enticing companies to hit the market while the going is good. Loan issuance hit a new high recently.

Source: JPMorgan

The demand is not only coming from registered funds, but also from hedge funds as well as CLOs, (companies that securitize these loan portfolios). CLO volume clocked at $52 billion last year, while market participants expected only about $15 billion for 2012. The expectation for 2013 CLO issuance is $65bn according to JPMorgan, and all that collateral will have to come from somewhere.

As market participants rotate out of HY bonds, which have been frothy for some time (see post), and into loans, we are seeing the beginnings of another QE-driven market frenzy. Covenant-light transactions are a large part of the primary market recently,
JPMorgan: - ... the number of covenant-lite deals priced in the leveraged loan market also remained heavy. Specifically, covenant-lite loans accounted for 41% of issuance this week ($10.5bn), which followed $18.9bn (53%) last week, $14.7bn (47%) in January, and $58bn (51%) in 4Q12.
... and deal leverage is increasing as well, with an average LBO at 5.5 times (according to S&P). This is still below the 6.2 record level reached in 2007, but in terms of the overall leverage we are roughly where deals priced during the 2005- 2006 period.

When the Fed looks for signs of liquidity-driven market pricing, the central bank won't need to look too far. The question is, are they looking at all?
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