Leveraged Loan Deleveraging In Action - Part 2

Includes: BKLN, DIA, SPY
by: The Nattering Naybob


Recent market action of SP100 Leveraged Loan Index and BKLN ETF which tracks it.

Through SP100, BKLN acts as a proxy for leveraged loan deleveraging and market liquidity.

Large weekly outflows and declines in BKLN have presaged SP500 market downturns.

Advisory: Due to timely relevance, this missive was updated on Friday 12/12/2014 when the SP500 had fallen from its high 2032 to 2018, subsequent plunge to close at 2002 warranted further review.

12/13/2014 UPDATE

BKLN long term support at 24.26 was violated on volume with conviction 12/02/2014 (the day we posted the original missive).

Note the pattern in chart below, from the 11/13/2014 peak on BKLN, exactly 15 trading days to arrive at market closing 12/12/2014.

Note the SPX remains in synch with BKLN. From the 11/13 high of 24.46 - 23.77(12/12 low) = -0.69 BKLN. Meanwhile, SPX from the 12/05 high of 2079 - 2002(12/12 low) = 77.

The S&P/LSTA Leveraged Loan 100 Index (SPFDLL) is tracked by BKLN. The SPFDLL index tracks "Senior loans, which are also called leveraged loans, syndicated loans, bank loans or floating rate loans, are typically issued in conjunction with leveraged buyouts, mergers or acquisitions."

Payments on these types of loans is usually senior to any other form of debt or equity. Principal and interest (P&I) are paid at a floating rate usually tied to LIBOR (London InterBank Offered Rate). To be included in BKLN loans from syndicated credits must be senior secured, have a one year minimum term, have a minimum spread of LIBOR +125 basis points, and be U.S. dollar denominated.

Recent market action could indicate sentiment regarding the credit market spreads for large institutional leveraged loans is souring and the spreads (costs) are widening. Despite the static of econometric central bank and media narrative to the contrary, this sentiment could be influenced by market participants anticipation of...

continued economic deterioration, secular stagnation; declining real income, consumer spending, revenues and share prices; future credit downgrades, capital erosion and the resulting default on the debt as the holders will not be able to exit their positions via IPO or sale, due to the assets having become illiquid.

Spreads widen when risk is perceived to be increasing. i.e. there is a distaste for the risk on the paper involved and the number of willing buyers declines. It would seem this asset class is becoming illiquid as even value seekers catching falling knives are reluctant to participate.

As the asset price falls, those who have stakes (are holders) in leveraged positions must liquidate (fire sale) other more liquid assets (cash equivalents, SP500 equities and U.S. bonds) to make up the difference in price for claims (collateral or margin calls) against the illiquid asset.

Through SP100, BKLN acts as a proxy for leveraged loan deleveraging and market liquidity. Thus, we may be witnessing the effects of off balance sheet assets (hedges, derivatives) and their associated collateral calls on the overall market.

We previously noted: "the interval for the last three dips has now gone 15, 13 and 15 trading days respectively." More importantly, the divergence appears to be when BKLN contracts (declines), illiquidity in the leveraged, high yield, junk debt asset class drags the larger SP500 down with it. At the moment, there appears to be a five day latency in the relationship.

Observing the chart above, the last occurrence of a deep V for BKLN was the week ending 10/17/2014. Large weekly outflows and declines in BKLN have presaged SP500 market downturns. Note the chart below courtesy of ETF.com displaying large outflows > $100M for the weeks of 08/01; 09/30; 10/17 and this last week - 12/11.

It would appear that BKLN is on the verge of violating long term 2011 and 2012 support levels at 23.83. Should BKLN violate this level on volume and with conviction, keep an eye out for further downside on the SP500 index.

Recommended Reading

Part 1 - Leveraged Loan Deleveraging in Action

For an excellent detailed analysis of BKLN and the underlying index SPFDLL (SP100 Large Leveraged Loan) by Reuben Sushman,

BKLN Is Yielding Almost 5%

Market Plays


Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.