When they talk about the recovery in the bank loan market, many market participants make much of the gains in prices, the drop in yield premiums and the decline in corporate defaults.
Market volatility, however, has not been talked about as much and it's a metric that should get more attention, according to market participants.
"With the leverage now mostly unwound, loans should become again what made them so desirable to those who use leverage in the first place," said a Boston-based investor who requested anonymity.
In addition to their senior secured perch at the top of the capital structure, leveraged loans have traditionally been desirable because of their low volatility.
Before the recession began, during the first half of 2007, the standard deviation — the measure of fluctuation in loan returns — for secondary loans was less than 0.1%, according to the data provider Markit.
This means that daily returns for leveraged loans fluctuated by less than 0.1% the majority of the time, and less than 0.2% over 95% of the time, as measured by the Markit iBoxx USD Leveraged Loan Index.
As the recession deepened, the standard deviation rose to an all-time high of more than 1% in the fall of 2008, illustrating just how volatile the secondary loan market had become.
During this time the standard deviation in the loan market mirrored the volatility in the high-yield bond market, though to a lesser extent. These two markets had never correlated so closely, and that was a problem because the shine on the stable, senior secured bank loan started to fade.
"The most difficult concept for most nonmarket participants to understand will be that loan stats should be considered both with and without the stats between 2007 and 2009, which painted loans with a volatility brush that is not deserved, nor inherent," the Boston investor said.
The investor continued: "It will be hard to drown out the noise of young traders, who feel compelled to view loans and high-yield bonds as moving together and forget that the correlation was less than 50% until the leverage spike, even though loans are often in the same capital structures as high-yield bonds."
By December 2009 the standard deviation in the secondary loan market had fallen below 0.1% again, surprising many market participants who had believed the market would remain volatile much longer. In the fall of 2009 almost three-quarters of respondents to a survey conducted by the Loan Syndications and Trading Association predicted the loan market would remain volatile.
As of last week the standard deviation had fallen to 0.08%.
"I'm surprised to see how low volatility has been recently," a Markit analyst said. "That said, steady returns with low volatility are reminiscent of the loan market pre-July 2007, which has the potential to bring in investors to the market."
Not only have prices remained less volatile, but loans on average have been trading around par. In March the Markit LCDX index reached an all-time high of 104.58. The previous record, 104.51, was set in January.
The average price on the series 14 index — the latest incarnation of Markit's secondary loan index — was 97.84 midweek.
Moreover, most loans have been breaking on the secondary around par, according to Standard & Poor's.
The loan market is not as insulated as it was in 2007, however.
There are still plenty of concerns about sovereign credit risk stemming from the debt crisis in Greece, and worries about the vigor of both the U.S. economic recovery and corporate earnings persist.