U.S. loan prices hold up well amid volatility
NEW YORK (Reuters) - U.S. secondary loan prices are seeing their first bout of weakness since the beginning of the year, pressured by macroeconomic concern that the Federal Reserve will slow its quantitative easing program which has already crushed high yield bond prices.
US leveraged loans had a relatively small 23bp correction to 98.82 on Thursday but remain well insulated as the only major fund class to see inflows last week. Nearly $1 billion of cash flowed into bank loan mutual funds, compared to a record $4.6 billion outflow from high yield, according to Lipper FMI.
"We have had a market in risk assets that has had a great start to the year," said Jonathan DeSimone, managing director at Sankaty Advisors. "It was probably looking for a reason to pause."
For secondary loans, the prospect that the U.S. central bank could soon ease off the monetary pump was the reason for the halt of a seemingly inexorable rise in prices.
Before risk markets got spooked, the average bid in the secondary market had risen to 99.05 on May 22, according to LSTA/Thomson Reuters LPC MTM Pricing, and loans bid above 101 accounted for 35 percent of the broader market.
In the two weeks after Federal Reserve Chairman Ben Bernanke's remarks that the Fed could step down the pace of its purchases as soon as September, average loan bids fell to 98.82 last Thursday and those bid above 101 halved to 17 percent.
European secondary loan prices have also fallen 51bp to 99.29 last Friday from a six-year high of 99.8 on May 14.
While the correction in U.S. secondary loan prices is expected to remain relatively small in comparison to high yield carnage, market softness looks to persist.
"I think it could continue. There's a little bit of a reassessment," said Jonathan Insull, managing director at Crescent Capital Group.
Loans are also being impacted by the poor performance of the high-yield bond market.
The two assets classes have often traded in sympathy, but loan prices have been under additional pressure as high-yield investors that bought loans are now selling to meet redemption demands, loan managers said.
The top 100 loans have seen a bigger 46bp decline from 99.12 to 98.66, according to LPC data. The sell-off in the most actively-traded loans also points to an exodus of hot money.
"The crossover buyers from high yield bonds were the sellers," said Steven Oh, head of Global Credit and Fixed Income at PineBridge Investments.
Although loan prices have weakened, a true sell-off or market rout similar to the summer of 2011 appears unlikely. Demand for loans remains strong from new Collateralised Loan Obligation (CLO) funds, strong inflows to bank loan funds and institutional investors adding the asset class into their portfolios.
These supportive pillars of demand are putting a floor under prices and loans are likely to trade in a narrow band. If loan prices fall substantially, the cash sitting on the sidelines promises to push them back up.
"If the market falls 1 percent or more, a meaningful amount of cash, particularly from CLO warehouses, can jump in and prevent prices from going much lower," said Oh.
Loans may prove to be less volatile than high yield bonds and may even outperform their subordinated counterparts. In the two weeks since the market volatility began, loans returned a negative 0.4 percent versus a 1.98 percent loss for high yield.
"Loans will trade in a tighter range than bonds," said Marc Boatwright, portfolio manager at ING Investment "There is much broader interest in loans across the investor base now, and I don't see that changing dramatically in the current environment."
Loans also enjoy the added benefit of providing interest rate protection as floating-rate instruments. Investors' preoccupation with interest rates is climbing as a premature tightening of monetary policy or improving economy would both lead to higher rates which are bad for bond prices, less so for loans.
Both markets however, as well as other risk assets, may be getting ahead of themselves, investors said. Any tapering of the Federal Reserve's bond-buying program will be gradual and slow, and will probably take many years.
"The market is very much fast-forwarding to the end of the movie," said DeSimone, who expects the Federal Reserve to "slow the buying, stop the buying and then sell."
Meanwhile, many loan investors and traders looking to buy and sell paper have welcomed the softening of toppy loan prices. Loan investors are also hopeful that the weakening of the market could stop the marginal repricings that continue to lower spreads and reduce their yields.
"Volatility, little movement here and there, is helpful to a good asset manager," Insull said.
(Editing By Jon Methven)
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