Loan Returns Mixed by Credit Quality
- Financial markets remained negative last week. U.S. market performance was impacted by weakening energy prices and a narrowing in the U.S. Presidential election polling data raising concerns. Markets also reacted to economic data over U.S. Non-Farm Payroll data which came in at the lower end of expectations. With rising expectations about future increases in short-term interest rates, floating rate continued its recent strong relative performance versus many other major financial assets (please see last bullet below). As we have communicated in prior weekly updates, we continue to expect heightened volatility as fundamental and technical market forces play out during the rest of the year (Standard & Poor’s LCD Weekly Wrap, 11/03/16, and J.P. Morgan Credit Strategy Weekly Update, 11/04/16).
- The calendar for floating rate loan issuance has remained strong since the beginning of October, with pent-up supply and rising demand. Last week, the rate of issuance slowed somewhat, with the launch of 18 deals for $6.4 billion, versus 24 deals for $19.1 billion in the prior week. The weekly average for issuance in 2016 is $8.6 billion. YTD 2016, the loan market has witnessed $377 billion in issuance, eclipsing the $288 billion in the same period of 2015. We continue to expect issuance in 2016 to maintain the trend we witnessed during much of 2015, with an erratic new issue calendar highlighted by smaller, less well-known issuers with occasional large, leveraged buyout (LBO) deals to round out the pipeline. Given the recent rebound in loan market trading levels, we have seen an increase in loan repricing activity. However, we continue to view the current environment as one favorable for fund managers to invest (Standard & Poor’s LCD Weekly Wrap, 11/03/16, and J.P. Morgan Credit Strategy Weekly Update, 11/04/16).
- Floating rate mutual funds realized $147 million of inflows last week, behind the $291 million reported in the prior week. This was the fourteenth consecutive weekly inflow recorded. YTD, mutual funds have realized $1.7 billion in outflows, which compares favorably to the $21.7 billion in outflows reported in the same period of 2015. Floating rate mutual fund AUM has now increased back to $106 billion this year, but is down 31% from the $153 billion peak reported in 2013. We remain constructive on the floating rate asset class, with positive overall fundamentals from below-average default rates for the foreseeable future (excluding potential defaults from the energy and metals & mining sectors), attractive reinvestment yields, and expected future increases in short-term interest rates (J.P. Morgan Credit Strategy Weekly Update, 11/04/16).
- The secondary trading levels for more liquid floating rate loans turned negative last week, as the LCD Flow-Name Composite decreased 0.45% to 98.87% of par, compared to the index decreasing 0.12% in the prior week. The current level of the composite has fallen from the high end of the range recorded over the last 12 months, and is at the same level last recorded in July 2016. It should be noted that this composite does not include any energy sector-related exposure, which has shown higher price volatility than the broader floating rate market since the beginning of 2015. The current average prices for floating rate assets remain at levels we believe offer value to investors, as illustrated in the following chart (Standard & Poor’s LCD Weekly Wrap, 11/03/16):
Average Institutional Flow-Name Loan Bid
Source: LCD, an offering of S&P Global Market Intelligence, 11/03/16.
- The floating rate loan market lost ground last week, as the S&P/LSTA Leveraged Loan Index decreased 0.08% for the week ended November 2, 2016, which compares to the 0.22% gain reported in the prior week. Loan returns were mixed by credit quality, as BB, B, and CCC loans returned negative 0.18%, negative 0.01%, and negative 0.28%, respectively. YTD 2016 loan returns are now 8.48%, and remain ahead of the 1.28% gain reported in the same period of 2015 (Standard & Poor’s LCD Weekly Wrap, 11/03/16).
- Market performance across asset classes for the week ended November 4, 2016 was negative. Treasury bonds and floating rate outperformed, as the 10-year U.S. Treasury Bond returned negative 0.06% and the S&P/LSTA Leveraged Loan Index returned negative 0.08%. All other major financial assets we track, including investment-grade bonds, high yield, and equities, underperformed, as the ML High-Grade Corp Index, Merrill Lynch High Yield Index, and the S&P 500 Index returned negative 0.26%, negative 1.43%, and negative 1.92%, respectively (Standard & Poor’s LCD Weekly Wrap, 11/03/16).
The S&P/LSTA U.S. Leveraged Loan Index is designed to reflect the performance of the largest facilities in the leveraged loan market.
Standard & Poor’s Leveraged Commentary & Data (LCD) Flow-Name Composite is designed to reflect the prices of the most liquid loans in the market.
The BofA Merrill Lynch U.S. Corporate Master Index (the Merrill Lynch High-Grade Corp Index) includes publicly issued, fixed-rate, non-convertible investment-grade, U.S. dollar-denominated, SEC-registered corporate debt having at least one year to maturity and an outstanding par value of at least $250 million.
The BofA Merrill Lynch U.S. High Yield Master II Index (the Merrill Lynch High Yield Index) tracks the performance of below investment-grade, but not in default, U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market, and includes issues with a credit rating of BBB or below, as rated by Moody’s and S&P.
The S&P 500® Index is a broad-based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general.
A basis point is a unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes, and the yield of a fixed-income security.
TXU is the commonly used abbreviation for Texas Competitive Electric Holdings Co. LLC.
Credit Ratings: AAA credit ratings apply to the underlying debt securities and are rated by an independent rating agency, such as Standard & Poor’s (S&P), Moody’s, and/or Fitch. S&P rates borrowers on a scale from AAA to D. AAA through BBB represent investment grade, while BB through D represent non-investment grade. Moody’s rates borrowers on a scale from Aaa through C. Aaa through Baa3 represent investment grade, while Ba1 through C represent non-investment grade. Fitch rates borrowers on a scale from AAA through D. AAA through BBB represent investment grade, while BB through D represent non-investment grade.
Treasury securities are backed by the full faith and credit of the United States government as to payment of principal and interest if held to maturity. Interest income on these securities is exempt from state and local taxes.
All mutual funds are subject to market risk and will fluctuate in value. Before considering an investment in a floating rate fund, you should understand that you could lose money.
Floating rate funds are generally considered to have speculative characteristics that involve default risk of principal and interest, collateral impairment, borrower industry concentration, and limited liquidity. Securities purchased by the Fund that are liquid at the time of purchase may subsequently become illiquid due to events relating to the issuer of the securities, market events, economic conditions, or investor perceptions. As a result, an investor could pay more than the market value when buying Fund shares or receive less than the market value when selling Fund shares.
The Fund may not be able to pay redemption proceeds within the allowable time period because of unusual market conditions, unusually high volume of redemptions, or other reasons. To meet redemption requests, the Fund may be forced to sell securities at an unfavorable time and/or under unfavorable conditions.
Liquidity risk may also refer to the risk that the Fund may not be able to pay redemption proceeds within the allowable time period because of unusual market conditions, unusually high volume of redemptions, or other reasons. To meet redemption requests, the Fund may be forced to sell securities at an unfavorable time and/or under unfavorable conditions.
Past performance is no guarantee for future results, which will vary.
The opinions expressed herein are subject to change without notice. This material is distributed for informational purposes only, and is not intended to constitute the giving of advice or the making of a recommendation. The investments or strategies presented are not appropriate for every investor and do not take into account the investment objectives or financial needs of particular investors. An investor should review with its financial advisors the terms and conditions and risks involved with specific products or services and consider this information in the context of its personal risk tolerance and investment goals.
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Fixed Income Investors is a multi-product fixed-income investment manager and a division of New York Life Investments. MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, New Jersey 07302.