Performing Credit

The U.S. leveraged loan market posted another strong quarter, with a quarterly gain of 1.18%. The J.P. Morgan U.S. Leveraged Loan Index ended the third quarter at a 4.77% yield and 414-basis point spread, reflecting 7 basis points of spread compression during the quarter. September was notable because leveraged loans provided their strongest performance since January despite September’s equity losses. The combination of record CLO origination and an expectation of rising rates drove retail inflows, leading to strong demand for new issue loans and allowing secondary prices to remain firm.

In Europe, the leveraged loan market posted a gain of 1%, while the high yield market posted a gain of 0.7%. The J.P. Morgan European Leveraged Loan Index ended the third quarter at a 4.3% yield and 385-basis point spread, while the J.P. Morgan European High Yield Index ended September at a 2.57% yield and 311-basis point spread—reflecting 4 basis points of spread widening during the quarter. It was generally an uneventful quarter, with valuation levels unchanged versus the second quarter. Leveraged loans were immune from the latest rates-induced wobble, with dollar high yield underperforming in spread terms but generating a superior total return due to a greater all-in yield.

U.S. high yield funds, including ETFs, posted inflows of $2 billion and leveraged loan funds posted inflows of $7.1 billion. In conjunction with strong demand, default rates continue to steadily decline; including distressed exchanges, defaults during the quarter totaled $1.1 billion, the lowest level since the fourth quarter of 2013. Including distressed exchanges, the trailing 12-month default rate as of September 30, 2021 was 0.99% for high yield and 0.89% for loans, as compared to 6.36% and 4.27%, respectively, as of September 30, 2020. In Europe, there were no defaults in the third quarter, and the trailing 12-month default rate fell 60 basis points to 1.5% as of the end of September.

While the ‘default deflation’ may be transitory, we believe loan demand will remain strong, as floating rate products have historically experienced an increase in investor focus in a stable-to-rising rate environment. Additionally, the global economic outlook is improving as COVID-19 vaccine distribution continues to expand and people begin returning to workplaces. Demand for CLO debt and equity remains robust, as CLOs benefit from low spreads, and locking in low spreads in the current environment will position CLOs well, as they typically have a 5-year investment period.

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The default rate continues to fall, with the trailing 12-month default rate falling just under 1%.

Amid concerns about inflation and interest rate increases, floating rate assets—including leveraged loans—saw continued investor interest.

Rating upgrades still outweigh downgrades, albeit more moderately than the strong ratio of upgrades to downgrades seen earlier in 2021.

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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