Performing Credit

The U.S. leveraged loan market started the year strong, with a first quarter gain of 1.88%. The J.P. Morgan U.S. Leveraged Loan Index ended the quarter with a 4.89% yield and 439 basis point spread, down 21 basis points and 47 basis points, respectively, from year-end. The European loan market posted a 1.9% return, outperforming the high yield market, which returned 1.5%. However, since the European loan market is dominated by B-rated issues, the performance gap between loans and bonds is closer than it appears, with B-rated European high yield returning 2.1%. Meanwhile, U.S. investors focused on lower rated credit, with split B/CCC loans—up 6.66%—strongly outperforming B and BB loans, which ended the quarter up 1.60% and 0.83%, respectively.

While the pandemic’s impact continues to be seen worldwide, the market was focused on positive news regarding vaccines and falling default rates. As of March 31st, the U.S. loan default rate—which has fallen for six straight months—was 3.34% and on-trend to continue falling toward a long-term rate of 2.9%. LCD predicts $30.8 billion will exit the rolling default number by July, putting downward pressure on the default rate. European high yield recorded no defaults in March, and the 12-month trailing default rate as of March 31st fell by 25 basis points to 3.35%. Rating upgrades also continued to outpace downgrades in terms of issuer count and par amount outstanding. The volume of ratings upgraded outpaced downgrades by more than 2x as of quarter-end.

The market saw economic improvement, as S&P Global Economics increased its real U.S. GDP growth forecast for 2021 from 4.2% to 6.5%. At the borrower level, the trend saw leverage falling and interest coverage rising, further reducing future default pressure.

The first quarter of 2021 marked the first reversal of outflows since 2018, with leveraged loan funds experiencing inflows of $25.5 billion. We expect demand for loans to remain robust in the near term, as CLOs—the largest buyers of loans—are actively ramping, as illustrated by the $37.8 billion of primary CLO issuance. In the U.S., first quarter 2021 primary issuance volume was the second-highest on record.

Looking ahead, we believe loan demand will remain strong in 2021, as floating rate products have historically experienced an increase in investor focus in a stable-to-rising rate environment. The global economic outlook is improving due to the expanding availability of COVID-19 vaccines, as is the default outlook, due to roll-off and improvement in borrowers’ credit fundamentals. Demand for CLO debt and equity remains robust, as CLOs benefit from low spreads, and locking in low spreads is the current environment will position CLOs well given that they typically have a 5-year investment period.

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Default rates continue to decline from the spike in 2020 and remain well below historical highs.

Leveraged loan fund outflows, which began at the end of 2018, have started reversing course in 2021.

Leveraged loan upgrades are outpacing downgrades as it relates to both issuer count and par amount outstanding. 

March had the highest monthly CLO issuance on record, making Q1 2021 the second-highest quarter on record.

Angelo Gordon’s Capital Markets Perspectives

AG Capital Markets Perspectives (“CMP”) provides our portfolio managers’ views on the credit, real estate, and private equity markets. To access this quarter’s CMP and past quarterly reports, please complete the form below.

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