CIO’s Perspective: 2017 Leveraged Credit Review and 2018 Outlook

Posted on January 4, 2018

2017 High Yield Market Review

For 2017, high yield bonds produced a gain of 7.48% (as measured by the ICE BofA Merrill Lynch U.S. High Yield Bond Index (“HYBI”)), representing the second consecutive year where the total return of the HYBI exceeded its start-of-the-year coupon. As reflected in Exhibit 1 below, strong gains during the first six months of the year largely drove high yield bond performance in 2017. 

Meanwhile, performance in the second half of the year lagged as optimism waned regarding the implementation of anticipated pro-growth policies in the U.S. Although tax reform eventually passed, the high yield market’s response to such news was muted given its passage in late December. In addition, geopolitical risks relating to North Korea and Russia in particular added uncertainty and volatility throughout the year. Nonetheless, high yield bond spreads tightened in 2017. This tightening served to offset the effect that resulted from the multiple rate hikes adopted by the U.S. Federal Reserve during the same period.

At the same time, leveraged loans produced a gain of 4.25% for the year (as measured by the JP Morgan Leveraged Loan Index (“LLI”)). Leveraged loans had a stronger second half of the year. This result was spurred by a decline in primary market activity and a rise in collateralized loan obligation (“CLO”) origination. These two factors led to a strong bid for secondary issues during that time. Conversely, throughout the first half of the year, leveraged loan prices were capped by the asset classes’ lack of call protection. According to Credit Suisse, approximately 62% of the leveraged loan market was priced above par at the start of 2017. That same figure was a mere 0.5% at the beginning of 2016. As a result, issuers took advantage of the friendly conditions in the primary market to adjust their balance sheets and lower their interest costs. All told, approximately 70% of the nearly $1 trillion of primary market activity for leveraged loans in 2017 was used for the repricing or refinancing of existing facilities.

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