August 16, 2017
After 15 consecutive months of net supply shortage, June saw a significant increase in net supply relative to inflows from mutual funds and CLOs. The U.S. leveraged loan supply/demand balance saw a supply surplus of $22 billion, compared to an average shortage of $7 billion since March 2016. The surplus in supply translated into weaker performance for the overall market, with the share of loans trading above par declining to 46 percent of the Credit Suisse Leveraged Loan index from 62 percent in February, culminating in the first monthly loss for the index since February 2016. On a positive note, the decline in loans trading above par has eased refinancing activity which dropped to 34 percent as a share of total institutional loan issuance in June, the lowest since May 2016.
The U.S. leveraged loan supply/ demand balance —net loan supply minus visible inflows—saw a supply surplus of $22 billion, compared to an average shortage of $7 billion since March 2016.
Source: S&P LCD, Guggenheim Investments. Data as of 6.30.2017.
The Credit Suisse Leveraged Loan index posted a 0.06 percent loss in June, but still gained 0.8 percent in the second quarter of 2017 as three-year discount margins tightened by 2 basis points quarter over quarter. This makes it the sixth consecutive quarter of positive returns in the loan market. Lower-quality loans underperformed higher-quality loans, with CCC loans losing 0.4 percent, versus gains of 0.7 percent and 1.1 percent for BB-rated loans and B-rated loans, respectively.
We remain positive on bank loans over the medium term as the fundamentals point to a continuation of lower-than-average default rates. The average interest coverage of loans outstanding is 4.3x based on the arithmetic average and 3.8x when weighted by issue size. Looking at historical data, we find that interest coverage below 3x is consistent with an uptick in defaults. Assuming earnings remain unchanged, the London Interbank Offered Rate (Libor) would have to increase to 3.0 percent for interest coverage to fall below 3x.
We remain positive on bank loans over the near- and medium-term as the fundamentals point to a continuation of lower-than-average default rates.
—Thomas Hauser, Senior Managing Director; Christopher Keywork, Managing Director
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