11 Jan 2018 07:00
Alcentra European Floating Rate Income Fund Limited
Market Commentary
December was a busy month for new Primary loans, with €4.4bn of new loan launches. Although this is a low figure in the context of a very busy year as a whole, it actually represents the busiest December on record as banks continued to launch new loan and bond deals throughout the month1.
This busy Primary market did mean that there was less buying momentum in the secondary loan market, and as a result the Credit Suisse Western European Leveraged Loan Index ("CS WELLI") (hedged to GBP) was subdued in December (+0.09%). This gives a year 2017 performance of +4.14% for a sterling hedged index return2.
2017 was a record year overall for new issue with €120.4bn of European loan volume, up from €69.7bn last year. Although €53.1bn of the 2017 figure comes from re-financings, which do not actually contribute to meaningful net new investment opportunities, the overall trend of increasing loan issuance has been gathering strong momentum3. This is key for us, both to allow for more investment choice and also to avoid greater pressure on pricing from excess market demand for loans.
Credit fundamentals remain strong, with European default rates hitting a low of 1.16% in November 2017, down from 2.4% in 20164. Leverage Ratios did increase in 2017, with average total debt/EBITDA reaching 5.3x in November. Although this is the highest figure since the financial crisis, it remains well below the 2007 figure of 6.1x5. As a result we continue to expect low default rates to continue into 2018 and we would anticipate 1.5% to 2.0% for the next 12 months6.
Portfolio Update
The Alcentra European Floating Rate Income Fund out-performed the index for the month and the year with NAV growth of +0.26% for December and +4.76% for 2017.
Top performing positions for the month were some of our junior debt holdings which were up between 1% and 2.5%. The weaker performers were two telecom positions that were down 1.7%, following on from some negative headlines around two large European credits, Altice and SFR, which both saw there junior bonds trade down in November.
We have continued to be conservative with our allocations to junior debt (3.2%) and High Yield bonds (7.6%). Both these asset classes are permitted within the fund with limits of 20% and 15% respectively, but for the immediate future we do not see compelling relative value versus the European Loan Market, and in the case of High Yield bonds, we believe the potential for volatility in 2018 makes a larger allocation currently unattractive for the fund. Although interest rates are on a rising trend in the US, currency hedged UK loan funds will not benefit from US rate rises, hence we do not believe they are currently compelling value versus European loans.
We will also continue to be very conservative on investments in Southern Europe, despite the economic improvements that have been achieved over the past 12 months. UK loans will also need heightened scrutiny as the Brexit process drags on.
Looking ahead to 2018, there clearly remains some scope for volatility with Brexit, more European elections (including Russia, Italy and Sweden), QE and Trump all likely to feature in the headlines. Although financial markets were remarkably immune from volatility last year, there is no guarantee that continues. But we would still expect European loan markets to be far more robust than bonds and equities.
Until we do see some meaningful volatility we expect demand for European loans to remain strong. New CLOs, unlevered loan funds and even banks, will all continue to drive demand. The supply/demand dynamic should however remain well balanced as we see a good pipeline of M&A and believe Private Equity firms have been deploying more capital and are open to looking at larger target companies. So whilst we don't see much scope for widening spreads, we would also expect that the global credit market repricing trend is not as pronounced as it has been in 2017.
ENDS
For further information please contact:
Alcentra Limited
Simon Perry +44 20 7367 5272
Factsheet
An accompanying factsheet which includes the information above as well as wider commentary on the investments made by the Fund can be found on the Fund's website www.aefrif.com.
Background Information
Alcentra European Floating Rate Income Fund Limited, a Guernsey Authorised Closed-Ended Collective Investment Scheme, regulated by the Guernsey Financial Services Commission and listed on the Main Market of the London Stock Exchange invests predominantly in senior secured loans and senior secured bonds issued by European corporates and targets returns (net of fees and expenses) of 7% to 10% per annum. The Fund targets a dividend yield of 5.5 pence per £1.00 issue price of the initial offering of shares in the Fund for the first full year of investment, paid quarterly.
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1 S&P Global Market Intelligence, LCD European Playbook, 2 January 2018
2 Credit Suisse Western European Leveraged Loan Index, hedged to GBP, 29 December 2017
3 S&P Global Market Intelligence, LCD European Playbook, 2 January 2018
4 S&P Market Intelligence, Default Survey: Rates to stay low in 2018, but focus on docs, 21 December 2017
5 S&P Market Intelligence, 2018 Loan Outlook: Players Positive after record breaking year, 19 December 2017
6 Alcentra 4 January 2018, S&P Market Intelligence, Default Survey: Rates to Stay Low in 2018, but Focus on Docs, 21 December 2017