The 2018 surge in asset growth at U.S. loan funds ground to a halt in October, with AUM increasing by a thin $360 million, down from $2.86 billion in September and from the roughly $3 billion average during the first nine months of the year, according to LCD and Lipper.

The October activity leaves loan fund AUM at $184.1 billion. That’s the tenth straight month in which a record was set for the asset class, but is an obvious downshift in the face of a now-volatile equities market and relative blizzard of mainstream financial press headlines—accompanied by stories with varying levels of sophistication—urging caution where leveraged loans are concerned.
The two elements most directly dictating AUM size each shifted dramatically last month.
Retail investors, for one, slammed on the brakes, as U.S. loan funds saw a $680 million net withdrawal in October, according to weekly reporters to Lipper. That’s the first monthly outflow for the asset class since December 2017, punctuated by a $1.5 billion withdrawal during the last week of October, the largest such move in almost three years.

Institutional investors in the loan secondary were likewise spooked, as bids per the S&P/LSTA Leveraged Loan Index dipped 47 bps in October, amounting to an $870 million hit to AUM. That’s the steepest drop since February 2016, when the U.S. market was limping through a particularly brutal stretch of outflows (and right before the market rebounded in anticipation of long-awaited rate hikes).

While there were a few credit-specific contributors to the market downturn last month—U.S. Silica missed on earnings and Clear Channel stumbled en route to reorganization, for instance—the sour sentiment brought about by the Fed, the Bank of England, and former Fed Chair Janet Yellen each calling out the market as an area of particular worry further bruised the asset class, sources say.
Looking ahead
The negative headlines continued into this month, as did bearish indicators regarding loan fund AUM growth for the remainder of the year. Most telling, Index bids have dipped another 51 bps so far in November, in part due to more issuer-specific results. Univision C-5 term debt, for one, slid after the company posted weak quarterly results and once again failed to renew its contract with DISH. And J. Crew dipped after the company announced the departure of its CEO and CMO.
Specific issuers aside, this month’s secondary decline has been broad-based, and comes despite largely positive earnings (more on that later). Indeed, increasing numbers of issuers hint that guidance down the road might not be as rosy as current numbers.
On the retail side, flows to U.S. loan funds rebounded from the dramatic withdrawals seen near Halloween, though certainly not to levels the market enjoyed previously. So far in November there has been a scant $176 million net inflow, per Lipper weekly reporters. 
More broadly, the market seems to have tapered expectations regarding the economy, certainly where rate hikes are concerned. While there remains consensus for another increase next month, the view toward 2019 has cooled. Where one month ago the market was expecting the first rate hike of 2019 in March, that event is now expected in June, according to CME. What’s more, a few months ago there was Street consensus for three or four rate hikes in 2019. Now, the market expects the June 2019 increase to be the only such move next year, per CME.

Lifting all boats?
While rate hikes generally benefit a floating-rate asset class such as leveraged loans, this can be a double-edged sword, of course, as increased borrowing costs eventually can slow issuers. For the time being, however, earnings continue to help mask the rising cost of debt. Indeed, while three-month LIBOR was up to 2.64% as of yesterday (it started 2018 at 1.69%), loan issuers just posted another impressive round of earnings growth, which swelled to 13% for the third quarter. That’s the highest it’s been in seven years (these numbers are for S&P Index issuers that file publicly).
Consequently, interest coverage for this issuer base just hit a record high of 4.6x, up 41 bps from the same period one year ago.
How long those earnings can mask higher borrowing costs remains to be seen. As noted, there are projections that corporate earnings are indeed peaking, meaning those haughty interest coverage numbers could well be under pressure, especially if LIBOR continues to rise.

As the above chart from our friends at the LSTA (via Barclays data) illustrates, when earnings growth returns to more normal levels—or disappears—the effects of increased borrowing costs on interest coverage can be significant. — Staff reports

Source：LCD News