By Jason Giordano
Despite three interest rate hikes, record issuance, and a total market size climbing toward the USD 1 trillion mark, the dominating theme for loans in 2017 has been the massive amount of repricings that have occurred throughout the year. As detailed in an earlier blog post, leveraged loans pay a two-part coupon - a market-driven base rate plus a contractual credit spread. The accommodative market conditions (i.e., high demand and limited supply) have allowed issuers of bank loans to renegotiate the fixed component of their interest payment via repricing.
Generally speaking, the appeal of leveraged loans in a rising rate environment is the floating nature of coupons - as interest rates increase, the base rate (typically 30-90 day LIBOR) also increases, providing market participants with a way to minimize interest rate risk while also generating extra income. As expected, both one-month and three-month LIBOR have increased 60-70 bps throughout the year and sat at 1.47% and 1.59%, respectively, as of Nov. 30, 2017 (see Exhibit 1).
As mentioned, market conditions have allowed issuers to reprice a staggering amount of loans throughout the year (see Exhibit 2). As of Nov. 30, 2017, a total of USD 520 billion of leveraged loans had been repriced in 2017. Perhaps more surprising is that this figure includes nearly USD 130 billion of facilities that have been repriced twice this year. Given the size of the market at the start of the year (USD 850 billion as per the S&P/LSTA Leveraged Loan Index), that translates to over 45% of the total market. The month of Nov. saw USD 79 billion in repricings - the second highest ever, following the unprecedented USD 100 billion of repricings that occurred in January.
Of course, the repricing impact has taken a toll on yields. Typically, repricings result in a reduction of credit spreads from 50 to 150 bps. For the first 10 months of 2017, repricing activity averaged 85 bps. That number fell to 64 bps for Nov., as there was less opportunity for spread savings, given the large repricings that had already occurred earlier in the year. Over the course of 2017, repricings have dropped the average weighted credit spreads of the S&P/LSTA Leveraged Loan Index from L+460 to L+382 (see Exhibits 3 and 4).
So, have repricings run their course in the loan market and, if not, how much more room is there for deals to reprice further? That all depends on market technicals (i.e., supply-demand imbalance).
The current expectation is for continued interest rate hikes through 2018, which should keep demand up for floating-rate assets. Additionally, as long as institutional investors are sitting on cash, loan issuers should benefit. Given the choice between cash returns or a repricing, institutional investors will continue to be accommodative to loan issuers.
As of Dec. 15, 2007, the S&P/LSTA U.S. Leveraged Loan 100 Index was up 3.07% YTD, while the broader S&P/LSTA Leveraged Loan Index had returned 3.88% (see Exhibit 5).