Leveraged Loans Are Sinking, Even as Junk Bonds Find Support

(Bloomberg) -- Credit found a floor over the last few days, but leveraged loans -- which fell later than other markets this quarter -- are still sliding. As long as funds keep pulling money out, loans will probably keep falling.

Floating-rate loans tend to track bonds, though they are often slower to react. Since Oct. 1, loans have lost about 2 percent, including a 1 percent drop this month, while both high-yield and investment grade bonds rose slightly.

Leveraged Loans Are Sinking, Even as Junk Bonds Find Support

"It’s a bit of a catch up," said James Schaeffer, deputy chief investment officer at Aegon Asset Management. "Aggressiveness -- on terms and structure -- has created more price volatility than in the high-yield market, now that we’ve seen demand for loans slow a bit."

Earlier in the year, several better-rated deals were priced at a margin of 175 basis points over Libor, the lowest level since the financial crisis. That left very little room for error, and prices on some of those loans have dropped 2 to 3 points since late October.

The pain may not end in the near term. There has been a significant exodus from loan mutual funds and ETFs in recent weeks, and the market is braced for more.

"Mutual funds may have more room to shed incrementally from here given their level of inflows YTD," Bank of America said in a strategy note.

Adding pressure, demand from collateralized loan obligations, the biggest and more reliable loan buyers, is also slowing.

The outlook is not all bleak. U.S. leveraged loans are returning 1.99 percent this year and some say they could outperform with a 6 percent gain in 2019. And with the recent sell-off, loans are looking cheaper compared to high-yield bonds, which could draw cross-over buyers.

©2018 Bloomberg L.P.