Performing Credit

The U.S. leveraged loan market posted another strong quarter, with a second quarter gain of 1.54%. The J.P. Morgan U.S. Leveraged Loan Index ended the second quarter with a 4.76% yield and 421-basis point spread, reflecting 18 basis points of spread compression during the quarter. The European loan market posted a 1% return, bringing the first half return to 3.1%. In the U.S., investors focused on lower-rated credit, with split B/CCC loans—up 3.61%—strongly outperforming B and BB loans, which ended the quarter up 1.55% and 0.84%, respectively.

Remarkably, June was the eleventh consecutive month that split B/CCC loans outperformed higher quality cohorts in the U.S. In the first half, split B/CCC loans posted a 10.51% gain, while B and BB loans posted 3.18% and 1.68% gains, respectively.

Illustrative of the strong rebound in fundamentals, default rates have been steadily declining, with 2021 marking the lowest first half for defaults since 2011. Despite the pickup in activity in June, both high yield bond and leveraged loan default rates declined significantly, as the large volume of bond and loan defaults from June 2020—$18.5 billion and $8.1 billion, respectively—exited trailing 12-month calculations. The par-weighted U.S. high yield default rate including distressed exchanges ended June at 1.87%, down 119 basis points from May and 489 basis points year-to-date. Meanwhile, the par-weighted default rate for loans ended June at 1.43%, down 53 basis points from May and 284 basis points year-to-date. In Europe, the projected default rate is similarly low, at 1.25% for 2021 and 1% for 2022.

The global CLO market surpassed the $1 trillion mark in June. $108.8 billion of U.S. CLOs, including refinancings and resets, priced in the second quarter. June saw the second-highest monthly volume on record, as 90 U.S. CLOs priced for an aggregate $42.4 billion. In the first half, 476 U.S. CLOs totaling $215 billion priced. Demand for CLOs was also seen in Europe, with 139 European CLOs pricing for an aggregate $61.5 billion in the first half of 2021, as compared to 69 deals for an aggregate $26.7 billion in all of 2020.

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. Additionally, the global economic outlook is improving as COVID-19 vaccine distribution continues to expand and people begin returning to workplaces. The default outlook is also improving 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 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 decline, particularly as the high default period of Q2 2020 leaves the lookback period.

The loan market saw increased investor appetite. Historically, the loan market has performed well in a stable-to-rising rate environment.

Improving fundamentals and wide-open capital markets led to there being far more rating upgrades than downgrades.

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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