Investors continued to pull money out of leveraged loan funds and ETFs in the final few market sessions of December, making it even more of a buyer’s market for CLOs.
According to Lipper data, another $525 million was withdrawn from loan mutual funds and exchange traded funds Monday, bringing withdrawals for the holiday-shortened week to $1.42 billion. (Fund flows are usually tracked from Thursday through the following Wednesday, but in this case the week was truncated both by the New Year's Day holiday and the desire to produce a final, full-year figure.) It was the seventh consecutive week of net outflows for the sector.
In a report published Wednesday, JPMorgan attributed the withdrawals to “recalibrated” expectations for interest rate hikes by the Federal Reserve's Open Market Committee, which announced on Dec. 19 that it projects only two increases to its target fed funds rate in 2019 instead of the originally projected three hikes. Loans pay floating rates of interest, which are more attractive to investors in a rising rate environment.
But the more leverage loans go on sale, the better the bargains for CLOs, which, like many mutual funds, are also actively managed, but, unlike mutual funds, generally do not have to mark the value of their holdings to market. Most CLOs have extremely high hurdles to meet before collateral liquidation is triggered, making them better equipped to withstand market volatility.
It's a far cry from start of the year, when CLO managers had to fight for collateral for new deals; many focused instead on refinancing or resetting older deals in order to extend their lives. New CLO issuance still reached a record volume of $130.7 billion for 2018 as a whole, buoyed by red-hot investor demand most of the year for floating-rate, higher-yielding assets.
The lighter schedule for rate hikes exacerbated concerns over rising risks in the loan market; current and former Fed officials have warned about the heavy debt loads of below investment grade companies.
The total drain from loan funds since Nov. 21 has been $14.88 billion, or a “considerable” 13.5% of the market of outstanding senior loans, JPMorgan reported. Leveraged loan prices were down in December with the JPMorgan Leveraged Loan Index of the most actively traded loans declining 2.31% to $94.54 (compared to par) - the largest drop since August 2011 (4.3%). Loans had been trading $99.07 to par as late as Oct. 5.
The unrest in the secondary loan market had a cooling effect on the primary market in December, with the $8.3 billion in institutional loan volume the lowest total for the market since January 2015 ($6.4 billion) amid the energy industry slump at that time. Gross new-loan issuance of the year finished at $703.7 billion, compared to $973.9 billion.
