Primary market yields on first lien middle market loans rose to their highest levels since Q1 2017 with increases in each quarter of 2018. This movement was driven heavily by the steady increase in LIBOR of over 100 bps throughout the year along with modest increases in coupon spread, most notably in the fourth quarter. First and second lien coupon spreads widened 35 and 33 bps respectively in the quarter, marking the largest quarterly spread widening in 2 years.
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Some middle market participants have attributed this rebound to optimistic factors such as a relaxation of the aggressive race to the bottom that started nearly two years ago. More common, however, is the opinion that the halt of compression and reversal in spreads is actually troublesome. The flurry of refinancing that occurred has already repriced all quality credits in the pipeline leaving the dregs of a white-hot lending cycle behind. The underlying causes are difficult to know for sure but what is certain is that the data shows that yield is out there, for better or worse.
The secondary market showed parallel movement with yields increasing modestly for BB-rated securities and up to 52 bps for lower-rated B- securities over the fourth quarter. Yield increases year-over-year proved to be a combination of the 110 bps increase in LIBOR offset by the remnants of coupon spread compression that was the hallmark of 2017.
Adding to this increase in yield at all credit ratings was a brutal December that saw a par plus market shift to over two-thirds of loans trading at a discount according to AdvantageData’s loan pricing service. Since 9/30/2018, over 90% of BDC-held middle market loans showed an incoming markdown as of the end of 2018.