The floating rate bank loan market has been a popular area for investment post the election. We have seen inflows into the space in 37 of the last 38 weeks, with $30bn coming into the retail loan funds (mutual funds and ETFs) over that time. YTD, we have seen $15bn flow into the retail loan funds, while we have seen $7.5bn flow out of high yield mutual and exchange traded funds. AUM for the retail leverage loan mutual fund base is now $136nn versus $92bn in February 2016.1 AUM in floating rate loan ETFs has increased from $14.3bn at the end of 2016 to $17.4mm as of mid-April.2
With all of this interest in the loan space, we are seeing strong new issue activity, as evidenced by the fact that seven of the year’s 16 weeks so far rank among the 10 largest weekly issuance totals on record. In terms of monthly issuance levels, March’s gross institutional loan issuance was the third highest monthly total on record, with February the fourth highest and January the highest on record. Year-to-date, loan new-issue volume totals $381.2bn, which already ranks as the fifth highest annual total on record and we are not even half way through the year. This issuance number includes a large amount of repricings and refinancings. Repricing has accounted for 48% of this issuance number and refinancing 32% of issuance.3 So a whopping 80% is coming from these two areas. To put this in perspective, over the past 6 months, we have seen $246bn reprice alone, which accounts for 27% of loans outstanding.4
With the huge wave of repricing activity in the loan market currently underway, we expect that to weight on yields/income generated going forward, as generally companies are looking to reprice the loan at a lower rate, anywhere from 50bps to a couple hundred basis points lower in terms of the spread. Loan spreads are generally priced off of LIBOR and the vast majority of loans have LIBOR floors, with most of those floors at 1%. So with LIBOR currently at 1.15%, we have only seen a 15bps increase in coupon income for most loans. While LIBOR rates are going up for the time being (with the increase starting last summer due to changes in money market rules), we don’t see them increasing enough to more than offset the spread cuts we are seeing in many of these repricings. For instance, since the election, we have seen LIBOR increase only 27bps, while other rates have increased much more (such as Federal Funds Target Rate and various Treasury rates). Some repricings are even eliminating LIBOR floors, meaning there could be even further yield downside should we at some point see LIBOR retreat again and stay at those low levels as we have seen for much of the last nine years.
We are seeing selective opportunities in the loan market, for instance, we are seeing some high yield bond issuers refinance their bonds with loans. But by and large, with the huge interest in and inflows into the loan space, we believe the index-based trade is overplayed and see the high yield bond market as better positioned for returns going forward. Loan ETFs have been a popular area for investment and the largest loan-based ETF tracks the S&P/LSTA Leveraged Loan 100 Index, which is designed to reflect the performance of the largest 100 facilities in the leveraged loan market, based on par amount outstanding. The nominal spread on this index is L+362 and yield to maturity is 4.5%5, versus a yield to maturity of 6.17% for the Bloomberg Barclays High Yield Index6. The YTD return is 1.45% for S&P/LSTA Leveraged Loan 100 Index versus 3.2% for the Bloomberg Barclays High Yield Index. The 10yr return is 4.37% for the S&P/LSTA Leveraged Loan 100 Index versus 7.46% for the Bloomberg Barclays High Yield Index.7
Our own active strategy is focused on high yield bonds but has the flexibility to include floating rate loans. We believe is a great option in environments such today, whereby we can expand our investment opportunity set to include both markets, can choose where in the capital structure (secured loans or senior bonds) we want to be positioned, and pick and choose the best yield opportunities relative to risk that we see in both the high yield bond and loan markets, all the while working to avoid the overvalued merchandise.