We are going through a demand shock created by global federal governments as they address a historic global public health crisis. The result, aside from the medical risks, is economic fear and panic as a catalyst for global recession. We believe this crisis is transitory and won’t last forever. While there will be winners and losers, the result has been asset valuations not seen since the Great Recession. At these levels long-term, patient investors could be stepping into a very attractive entry point, if history is our guide.
Fear and panic have taken over, making any discussion of valuation and relative valuation almost immaterial. At current trading levels, we are now wide to any time period in the history of the loan market except for the Great Recession. At a 76.25 dollar market price, spreads have blown through long-term averages and are currently north of Libor+1200 bps on a three-year discount basis as of 3/23 market close.
March 2016: L+780 bps / $91.5 (Energy Crisis)
November 2011: L+723 bps / $92.6 (U.S. Downgrade)
December 2008: L+2,474 bps / $62 (Great Recession)
October 2002: L+644 bps / $92 (Post 9/11)
As of 3/24, the state of the market is as follows (according to Credit Suisse data):
- We now have $672B of loans trading below an 80 dollar price, far surpassing the previous record of $472B hit during Fall 2008. This number is more than 4x the $149B we saw just one week ago on March 16th, and now represents 57% of the entire market.
- That 57% number is a big uptick from 13% on March 16th and 38% later last week (and 4% at the end of 2019).
- 97% of our market is now trading below 90 as compared to just 16% two weeks ago.
- 15% of loans are trading below 70, up from 2% at the end of 2019.
Historically, when the market is at such distressed levels, it has been an attractive entry point for long-term investors.
Risk assets are melting down because there is simply no clear path to a treatment or vaccine. In my opinion, investors naturally find it difficult to invest without knowing the duration of this public health crisis. Instead, cash becomes the investment of choice and risk assets (or assets in general right now) are indiscriminately sold. That this is a medical crisis is important. The financial system is working with the full resources of the Federal Reserve and global central banks as well as governments around the world. The banks are in much better shape today compared to 2008. The loan market is also in a position where there is much less leverage in the system and the underwritten forward issuance calendar is de minimis compared to 2008 levels.
At Newfleet, we are well into our process with our analyst team reviewing each company’s ability to manage through a period of negatively impacted operating results. We have discussed with every analyst the ability of our borrowers to cover fixed charges – including near-term maturities – with cash from operations. We have sensitized, as best we can right now, for a 2-3Q downturn. Severity depends on the business and industry. We then compared these results with the borrowers’ existing cash balance, line of credit availability, and the companies’ ability to pull cash-generating levers such as reducing capital expenditures or cutting dividends. There will be defaults, winners, and losers.
Nonetheless, technicals are winning the day with liquidity needs sometimes resulting in bids multiple points lower than previous day’s marks. There are no retail or even institutional buyers at the moment as shown in the retail fund flows and collateralized loan obligation (CLO) creation tables that follow.
Loan Fund Flows (U.S.)
Source for these two exhibits: LCD, an offering of S&P Global Market Intelligence.
Monthly U.S. CLO Issurance Breakdown
As I have mentioned in previous updates, the largest loans and higher quality loans are underperforming as mutual funds look to meet redemption requests. For context, the loan market was down 28.1% (Credit Suisse Leveraged Loan Index) in 2008.
Source: LCD, an offering of S&P Global Market Intelligence; S&P/LSTA Leveraged Loan Index
Coronavirus-related industries are being impacted the most, as indicated in the table below (as of 3/23).
Source: JP Morgan
Regarding the Senior Floating Rate Fund, below is the latest portfolio positioning (as of opening 3/23) as it relates to first derivative coronavirus-related industries affected. Naturally, the true impact is not yet quantifiable, but this is our attempt to illustrate the more obvious exposures.
Restaurants: None (minimal exposure of 0.34% in Golden Nugget)
Movie Theaters: None
Theme Parks: None
Cruise Lines: None
Ski Resorts: None
At a loan portfolio price of 76.8, and this current portfolio positioning, our recommendation is to hold through the volatility and use dividend reinvestment as a small way to dollar cost average into what has been historically attractive levels in the loan space.
IMPORTANT RISK CONSIDERATIONS
Credit & Interest: Debt securities are subject to various risks, the most prominent of which are credit and interest rate risk. The issuer of a debt security may fail to make interest and/or principal payments. Values of debt securities may rise or fall in response to changes in interest rates, and this risk may be enhanced with longer-term maturities. Bank Loans: Loans may be unsecured or not fully collateralized, may be subject to restrictions on resale and/or trade infrequently on the secondary market. Loans can carry significant credit and call risk, can be difficult to value, and have longer settlement times than other investments, which can make loans relatively illiquid at times. Leverage: When a fund leverages its portfolio, the value of its shares may be more volatile and all other risks may be compounded. Liquidity: Certain securities may be difficult to sell at a time and price beneficial to the fund. Prospectus: For additional information on risks, please see the fund’s prospectus.
Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates, or its sub advisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.
The S&P/LSTA Leveraged Loan Index is a daily total return index that uses LSTA/ LPC Mark-to-Market Pricing to calculate market value change. On a real-time basis, the index tracks the current outstanding balance and spread over LIBOR for fully funded term loans. The facilities included in the Index represent a broad cross section of leveraged loans syndicated in the United States, including dollar-denominated loans to overseas issuers. The index is unmanaged, its returns do not reflect any fees, expenses, or sales charges and it is not available for direct investment. The Credit Suisse Leveraged Loan Index is a market-weighted index that tracks the investable universe of the U.S. dollar denominated leveraged loans. The index is calculated on a total return basis, is unmanaged and not available for direct investment. The unmanaged index returns do not reflect any fees, expenses, or sales charges. LIBOR: London Interbank Offered Rate.
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