Fundamental factors underlying the corporate sector continue to underscore our constructive stance on leveraged credit, however, investors should prepare for heightened Q4 volatility amid shifting technical dynamics in the bank loan market.
- The U.S. Federal Reserve (Fed) on September 18 announced it would not taper quantitative easing (QE) and reiterated that asset purchases are not on a preset course. This announcement is likely to keep volatility elevated as investors continue to speculate on when tapering might begin.
- Buoyed by $17 billion of inflows in the third quarter, bank loans rose by 1.5 percent. Amid inflows of $7.9 billion, the high yield sector posted a third quarter return of 2.4 percent, rebounding from over $10 billion of outflows and a negative return of 1.4 percent in the second quarter.
- Recent regulatory changes have caused CLO liability costs to rise by 25 basis points since April 2013. Over the same period, loan spreads tightened by 80 basis points, causing CLO asset-liability spreads to narrow. This reduced arbitrage has led to a slowdown in new CLO origination.
- Since 2008, the retail share of the loan market has grown to 24 percent from 3 percent. The decline in CLO activity may cause the primary loan market to become increasingly dependent on retail demand, a technical dynamic that may induce greater volatility in bank loans.
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