US leveraged loan performance improved in July after hitting a rough patch in June, although returns continue to lag supercharged levels from earlier this year. The tech rout affecting broader financial markets weighed down returns last month, given the sector’s large footprint in the loan asset class, especially within the B-minus cohort. On a bright note, repricing and refinancing activity tapered off in July as focus shifted to much-needed LBO and M&A financing, although the massive supply/demand imbalance persists.
July highlights:
- Loans gain 0.68%, up from June but below 2024 average levels
- Software, which accounts for the largest slice of the index, underperforms for a second straight month, compressing B-minus and overall index returns
- Higher-rated names outperform in July but lag year-to-date
- Secondary prices stay on par with end-of-June levels
- The loan market continues to shrink — both the number of issuers and number of loans is the lowest since the fourth quarter of 2018
- Repricing and refinancing activity takes a backseat to LBO and M&A financings, indicating potential for growth
Drilling deeper into the returns picture, the Morningstar LSTA US Leveraged Loan Index gained 0.68% in July, up from 0.35% in June, which was the weakest month so far this year. Market-value return, which measures changes in secondary prices, declined 0.10% last month, the third negative reading in four months but marking an improvement over the 0.40% loss in June. On average, loans have gained 0.05% per month on a market-value basis and 0.83% on a total return basis over the last 12 months.
In the year to July 31, loans have gained 5.12%, trailing the first seven months of 2023 (up 7.85%) but outperforming comparable periods in 2020, 2021 and 2022. Loans have gained roughly 3.4%, on average, in each January-through-July period since the end of the Global Financial Crisis.
Loans continue to benefit from higher base rates — all of this year’s return has come from coupon-clipping. The interest return, which reflects the base rate and nominal coupon on the loan, is 5.50% in the year to date, a record high, up from 5.45% at this time in 2023. For reference, this metric averaged roughly 2.87% for comparable periods between 2013 and 2022.
The weighted average bid of the loan index closed July roughly on par with end-of-June levels, at 96.60. The latest weighted average bid level is 39 bps below the intra-year high of 96.99 in mid-May and 40 bps above the intra-year low of 96.20 at the beginning of February. The weighted average bid ended 2023 at 96.23.
Although average prices did not budge from June levels, the share of performing loans priced at par and above perked up in July, to 52%, up from 44% in June, but below the intra-year peak of 65% in mid-May. This cohort grew last month, while the share of the index that belonged to the 99-to-just-below-par category contracted to 22%, from 31% in June. In total, 74% of the index by par amount was priced at 99 or above by the end of July, roughly in line with the preceding few months.
Bid distribution data by credit quality shows improving market tone across the board. By the end of July, 37% of loans issued to companies rated B-minus were priced at par or better, up from 31% in June but below the recent peak of 51% in mid-May. At the end of March, 27% of these issues belonged to the par-or-better cohort. Last year’s peak was 17%. These riskier loans account for 26% of the overall loan market by par amount outstanding, the most for any ratings bucket. Higher-rated loans followed a similar trend. Roughly 60% of names falling between B-flat and BB-minus belonged to the par-or-better group, up from around 50% at the end of the second quarter.
An increase in the share of loans at par or higher will continue fueling this year’s repricing wave, which receded somewhat in July. Speculative-grade borrowers lowered the spread on $48.3 billion of loans via an amendment process last month, a significant decline from the record-breaking $115 billion in May. However, by historical standards, July’s tally is still notable — only a handful of months saw repricing volume over $40 billion in the five years, prior to 2024. Looking at the past repricing waves, activity spiked alongside the elevated share of loans priced at par or higher.
Speculative-grade borrowers have approved $426 billion of repricing amendments over the last seven months, or $454 billion when including a handful of re-syndicated repricings done via a refinancing. These figures eclipse the prior record pace set in 2017, which was $356 billion for all repricings through July.
On average, companies reduced the borrowing spread by 54 bps via these transactions, translating into $2.4 billion of annual savings. Putting these numbers into perspective, 34% of the $1.4 trillion loan asset class has been repriced this year, based on the Morningstar LSTA US Leveraged Loan Index.
M&A underway
Refinancing and repricing activity tapered off in the leveraged loan market in July as focus shifted to increased LBO and M&A financing — a welcome development to supply-starved investors. Total primary market deal activity was $86.3 billion in July, a three-month low and just half of the record-breaking $179 billion launched in May. However, $23.8 billion — or 28% — of July’s total primary market activity came from transactions not related to a refinancing or a repricing. In fact, this was the highest volume of non-refinancing-related issuance — a proxy for net supply — since January 2022, before the Fed started hiking rates. The average over the last 29 months was just $11.1 billion. At $23.8 billion, July activity comes very close to the $24.9 billion monthly average in the five years prior to the rate hiking cycle.
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