Loans Versus Bonds Relative Value: Week of October 29

After hitting stupid tights of 236 bps in the prior week, the secured-unsecured spread started widening marginally again, going back to above 250 bps. And while the bulk of moves by the index constituents were noise based, except for TRW's presumably erroneous reading of a 450 bps tightening in loans to 157 bps, the question remains of whether there is any principal upside left or whether new investors will be stuck collecting meager spreads over a virtually non-existent LIBOR in the loan universe, while bonds are dependant on the vagaries of the stock market, and thus the Fed.

We are not the only ones to question where we go from here. A commentary from Loan Connector highlights the increasing concerns of fixed income investors regarding future returns, even as the leveraged loan universe has returned over 40% YTD:

Loan returns were very strong in the second quarter, but have tempered in recent months. Loans returned a positive .54% in October, down from 3.2% in September, and a high of 8.7% in April. This was largely due to the fact that after a spectacular rally, bids leveled off in the past few months. As of the end of October, bid appreciatiation drove returns up 0.19% compared to 2.83% in September and a high of 8.19% in April. Last October, in the aftermath of the Lehman collapse, huge drops in bid levels dragged returns down by 14%. For now, many wonder if there is anymore upside in the secondary? Some say highly rated credits are already highly bid, while lower rated credits have seen a spectacular and in some cases, unwarranted rally. Meanwhile, the interest component is continuing to provide steady returns, providing a positive .35%-.34% return over the past 5 months. The fact that more and more deals have LIBOR floors is also helping to offset the dramatic decline in the LIBOR rate and keeps the income component of returns steady. Given the recent leveling off in the secondary, the income component is driving the bulk of the smaller, albeit still positive return for October.

Source: LoanConnector