High Yield Bond & Leveraged Loan Week in Review

Posted on March 20, 2020

March 13 - March 19, 2020

After a tumultuous five days of market activity ending Thursday, March 12th, the high yield bond and leveraged loan markets were enjoying a day of moderate gains and relative calm last Friday. Subsequently over the weekend, several actions taken by various levels of government led market participants to conclude that the COVID-19 outbreak would begin impacting economic activity far more tangibly than perhaps originally contemplated. The unexpected announcement by the Federal Reserve, which included a reduction of the Fed Fund’s rate to near zero as well as the re-initiation of its quantitative easing program, further confirmed these fears. These combined events sent equity futures tumbling on Sunday evening. Not surprisingly, when markets opened on Monday, all markets, including the high yield market, reacted negatively to this news. In our view, market participants likely perceived the actions taken by the Fed as a signal that things in the market and economy were much worse than originally thought.

As the week progressed, headlines related to the COVID-19 outbreak dominated news flow. It became clearer during the week that the guidance from the federal, state and local governments for citizens to practice social distancing as well as to reduce/restrict travel would have quite significant effects on the economy. Some notable headlines from the past week included the following;

  • The Trump administration acknowledged that a recession is likely already underway;
  • S&P placed Delta, American and United all on CreditWatch negative;
  • The three largest movie theater operators in the U.S. temporarily closed all theaters;
  • Nevada mandated the closure of all non-essential businesses, including all casinos, for 30 days; and
  • States and localities across the nation announced the closure of public schools.

While Congress has already passed two emergency spending bills to provide relief to those affected by COVID-19, it appears that more fiscal stimulus is on the way to support the economy during this uncertain time. As Chart 1 below shows, the last five trading sessions have been extremely volatile, and although not shown, the same holds true for the entire month of March as well. It is worth noting that Wednesday’s loss was the worst single day of performance on record for the Credit Suisse Leveraged Loan Index and the fourth worst for the ICE BofA US High Yield Index. One can also see from the chart that the moves in performance this week are well above the daily averages experienced during the first two months of the year.

 

Chart 1 – Leveraged Credit Daily Performance (%)
March 13th – March 19th

Chart 1 Leveraged Credit Daily Performance

Sources: ICE, Credit Suisse

Furthermore, all sectors of the high yield bond market generated losses during the past week. Such across-the-board losses were also true during the previous week as well as for the year-to-date period. However, what has changed week-over-week is the dispersion in sector returns, which is laid out in Table 1 below. As one might expect, the Energy and Leisure sectors have been the worst performers for the past two weeks. However, the median return for the past week has become more negative as economic issues extend beyond Energy and Leisure. As of March 19, 2020, the year-to-date return for the ICE BofA US High Yield Index was -18.31%.

 

Table 1: ICE US High Yield Index Total Returns
and Sector Return Dispersion (%)

 

March 7th - 12th

March 13th - 19th

US HY Bond Index Total Return

-8.92

-9.79

Average Sector Return

-7.74

-9.62

Median Sector Return

-6.44

-9.71

Max Sector Return

-4.91

-6.55

Min Sector Return

-27.01

-15.60

Source: ICE

Additionally, Table 2 reveals that all sectors of the leveraged loan market produced negative performance during the past five trading sessions. March has also been a bad month for the performance of leveraged loans, not at all unlike that experienced by their high yield bond peers. Furthermore, dispersion has diminished week-over-week as all sectors of the leveraged loan market are “catching down” to the dismal performance experienced by the Energy sector last week. For the past two weeks, the Energy and Metals/Mining sectors have been the worst performers, with Gaming/Leisure a close third. Similar to their high yield counterparts, the median sector return for leveraged loans during the past week has become more negative as the reality of the looming economic contraction has begun to set in across all industries. As of March 19, 2020, the year-to-date return for the Credit Suisse Leveraged Loan Index was -17.27%.

 

Table 2: CS Leveraged Loan Index Total Returns
and Sector Return Dispersion (%)

 

March 7th - 12th

March 13th - 19th

CS Lev Loan Index Total Return

-6.14

-10.89

Average Sector Return

-6.51

-10.93

Median Sector Return

-5.82

-10.70

Max Sector Return

-2.60

-7.33

Min Sector Return

-16.15

-16.37

Source: Credit Suisse

In addition, given the current market volatility, high yield bond and leveraged loan mutual funds have experienced outflows in 2020. Chart 2 below shows that these outflows have accelerated since the end of February. Specifically, more than 80% of the outflows from high yield bond and leveraged loan mutual funds have occurred in March, with outflows from leveraged loan funds increasing notably during the past week. Furthermore, this outflow activity has resulted in additional pressure on the prices of high yield bonds and leveraged loans, and it appears that limited forced selling by certain market participants has begun, further contributing to pricing pressure.

 

Chart 2 – Weekly Fund Flows ($mn)

Chart 2 Weekly Fund Flows

Sources: Lipper; J.P. Morgan

In light of this last point, while investors, including DDJ, would like to take advantage of the bargains being created by the current dislocation in the market, buyers are nonetheless exercising caution given the fluidity of the situation and the associated volatility in the market. Moreover, the uncertain market environment has caused primary market activity to come to a screeching halt, as no deals have priced in either market during the past week. DDJ expects this dearth of primary market activity to continue for the foreseeable future.

Furthermore, market liquidity is much thinner as compared with a more normal market environment. At this point, most of the trading activity in the high yield market is occurring in higher quality names that are traditionally more liquid. In addition, rather than making markets themselves, most brokers are trying to match orders from customers with a buyer or seller. Finally, while trading activity is still taking place, trades are being executed at lower prices and volumes relative to their levels just a few weeks ago. 

   

Chart 3 – ICE BofA U.S. High Yield Index Option Adjusted Spread in Basis Points (bps) –
December 31, 1997 through March 19, 2020.

Chart 3 ICE BofA U.S. High Yield Index Option

Source: ICE

The last item that we would highlight is the historical option adjusted spread (“OAS”) data for the ICE BofA US High Yield index, which is set forth in Chart 3 above. One can observe that the OAS for the index has now surpassed the local peaks reached during the commodity sell-off in 2016 and the Eurozone debt crisis of 2011. However, based on the historical OAS data, together with the current trajectory of the economic outlook for the near-term, it is unlikely that the current OAS represents the apex for this ongoing crisis, but rather that the OAS is on its way even higher. Furthermore, we would also point out the rate at which the OAS has climbed recently. There is no other period in the market’s history where the OAS has moved higher with such speed, indicating to us that the fear factor associated with the current global COVID-19 crisis is affecting the high yield market unlike any other previous period.

In summary, this past week’s headlines and trading activity have created a great deal of volatility in several markets, including the leveraged credit market. It is our expectation that market volatility will continue for the foreseeable future, as governments across the globe grapple with the challenge of containing the outbreak of COVID-19. However, notwithstanding the uncertainty associated with the public health and global economic consequences associated with COVID-19, DDJ believes that the current market environment will offer numerous opportunities to acquire high yield fixed income investments in fundamentally sound companies at more attractive valuations than we have recently observed. As such, we are examining companies in which we have not currently invested on behalf of our clients that have been particularly impacted by the current weakness (e.g., businesses in the Travel, Leisure, Gaming, and Energy sectors).  Nonetheless, considering the current uncertainty, we remain cautious in accumulating full position sizes until this volatile and ever-changing situation further plays itself out.

Appendix - Additional Charts as of March 19, 2020


Chart 4 – ICE BofA US High Yield Index Evolution of YTD
Performance (%) by Quality

Chart 4 ICE BofA US High Yield Index Evolution

Source: ICE

 

Chart 5 – ICE BofA US High Yield Index YTD
Performance by Sector (%)

Chart 5 ICE BofA US High Yield Index YTD

Source: ICE

 

Chart 6 – Credit Suisse Leveraged Loan Index YTD
Performance (%) by Quality

Chart 6 Credit Suisse Leveraged Loan Index

Source: Credit Suisse

 

Chart 7 – Credit Suisse Leveraged Loan Index YTD
Performance (%) by Sector

Chart 7 Credit Suisse Leveraged Loan Index YTD

Source: Credit Suisse

 

Chart 8 – ICE BofA US High Yield Index Cumulative
Performance (%) by Quality –
January 1, 2019 to March 19, 2020

Chart 8 ICE BofA US High Yield Index Cumulative

Source: ICE

 


The information and views expressed herein are provided for informational purposes only, and do not constitute investment advice, are not a guarantee of future performance, and are not intended as an offer or solicitation with respect to the purchase or sale of any security. The inclusion of particular investment(s) herein is not intended to represent, and should not be interpreted to imply, a past or current specific recommendation to purchase or sell an investment. Any projections, outlooks or estimates contained herein are forward-looking statements based upon specific assumptions and should not be construed as indicative of any actual events that have occurred or may occur. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Investing involves risk, including loss of principal. Investors should consider the investment objective, risks, charges and expenses carefully before investing with DDJ.
Past performance is no guarantee of future returns.

Q&A with the PMs of DDJ's U.S. Opportunistic High Yield Strategy