The leveraged loan market took a back seat to the CLO market in August. Like a player trying to keep warm for the fourth quarter, loans remained on the proverbial spin bike, on the sidelines, while CLOs printed the largest monthly total in the history of the market.

While CLOs priced $19.5 billion of new deals, the loan primary market essentially closed for the last two weeks of August and the first week of September.

Record CLO Issuance in August

Source: Credit Suisse, LCD

No need to fret, the net new issue calendar has over $31 billion of pending loan primary, which began launching the day after Labor Day. In fact, dealers suggest that the fourth quarter will be extremely busy with mergers and acquisitions (M&A) activity.

Year-to-date, there have been over $1.8 trillion in M&A announced in the U.S. and more than $3.6 trillion globally, according to Dealogic. The year-to-date numbers surpassed the previous record in 2015.

With little new issuance in August and record setting monthly demand from CLOs, we saw loan prices climb. At the end of August and beginning of September, the loan market had a cumulative price increase of 25 basis points (bps) over 11 sessions, the strongest stretch since April.

Performance – Loans

In August, the Credit Suisse Leveraged Loan Index (CS LLI) was up 0.49% and the S&P Leveraged Loan Index (S&P/LSTA) was up 0.47%. YTD returns for the CS LLI and S&P/LSTA are positive 3.98% and 3.76%, respectively.

For the 12 months ending August 31, the CS LLI was up 8.50% and the S&P/LSTA was up 8.39%.

In August, returns by rating were tightly clustered around the overall index returns with the exception of triple Cs and Distressed loans. Triple Cs outperformed all categories with a 1.29% return during the month while distressed loans lagged and were up just 7bps in August. However, the remainder of the categories had only 12bps separating the top and bottom performing categories. On a year-to-date basis, lower quality outperformed higher quality in every category.

On an LTM basis, risk outperformed as triple Cs led all categories with a 28% return. Single Bs produced an 7.64% return and double Bs returned 4.38%.

Total Return by Rating

Source: Credit Suisse Leverage Loan Index

Sector Performance

In August, all 20 sectors in the CS LLI produced positive returns. Dispersion contracted between the top performing sector and the bottom performing sector with just 74bps separating the two. Metals/Mining led all categories followed by Media/ Telecommunications and Energy. The bottom performing sectors were Retail, Food/Tobacco and Utility with total returns of 0.35%, 0.34% and 0.01%, respectively.

In the last 12 months, Energy, Metals/Minerals and Consumer Non-durables have led all sectors with total returns of 20.06%, 17.12% and 14.96%, respectively. Forest Products/Containers, Financial and Utility provided the worst performing sector returns: 6.34%, 5.41% and 2.28%, respectively.

Industry Returns

Source: Credit Suisse Leveraged Loan Index

The average bid of the S&P LCD flow-name loan composite increased from 98.83 on August 5 to 99.10 on September 2. During the same time period the broader CS LLI increased 45bps. The lack of supply combined with all the newly minted CLOs just led to a grind higher in loan prices. As liquid loans moved above par, investors looked to find any discount in the broader index.

Average Loan Flow-Name Bid

Source: LCD, an offering of S&P Global Market Intelligence

Performance – CLOs

August CLO performance was slow and steady in the secondary markets as BWIC activity declined and spreads remained largely flat month over month with the spotlight very much on the record-breaking primary market. Overall, CLOs returned 0.19% in August, almost flat to July, with interest returns being the main driver of performance. CLOs outperformed IG credit (-0.24%) and underperformed HY (+0.51%) and Loans (+0.47%) during the month. Year to date, CLOs are returning 1.9%, outperforming IG (-0.23%) and underperforming HY (+4.55%) and Loans (+3.76%).

CLO AAA spreads remained rangebound over the month with the majority of bonds trading above par in the $100.05 to $100.1 range. Demand was robust as dealers continued to get called out of bonds and investors looked for shorter duration, cash-like substitute profiles. Shorter duration AAAs traded in the 80-100 discount margin (DM) range with longer AAAs in the 110-115 DM context. AAs were also well bid with most Tier 1 AAs trading in the 140s-150 DM with lower tier AAs trading in the 160s DM.

Single As and BBBs saw good demand as investors are still able to find some discount dollar-priced bonds in those tranches that provide the opportunity to capture some positive convexity. Single A spreads were unchanged with Tier 1 bonds trading inside 200 DM. BBBs were slightly weaker, especially for lower tier bonds given the heavy supply in primary. BB followed suit with spreads 5-10bps weaker although fundamentals and MVOCs remained strong. Equity trading declined given August was a non-payment date month. As a result, equity BWIC activity declined by almost 60% m-o-m with NAVs stable.

Overall trading activity was roughly flat with TRACE reporting $8.4 billion in total volume, but still relatively high for what is usually a slow month. However, BWIC volumes were down over 30% with only $1.2 billion in BWIC activity recorded in August. Additionally, dealers were lighter by almost $250 million, mainly in IG rated bonds, over the course of the month.

Secondary CLO 2.0 Total Returns

Source: J.P. Morgan CLOIE Index

Secondary CLO 2.0 Spreads (DM)

Source: TCW

Technical Conditions – CLO Primary

The CLO primary market continued to break records with new issuance at its highest monthly amount in post crisis history with a whopping $19.4 billion of issuance across 32 deals. This amount handily beats out the previous high of $16.2 billion in March 2015. Refi and reset activity remained strong but not record breaking with $3.7 billion of refi and $12.9 billion of reset volume pricing in August for a combined issuance total of $35.5 billion, under the $50 billion issued in March. YTD issuance surpassed $100 billion in August to $112 billion, putting annual issuance for 2021 66% ahead of the average and on pace to break issuance records on the year.

New issue CLO spreads widened slightly across tranches with spreads for 5nc2 new issue deals hovering around 115 DM for AAAs, 165 DM for AAs, 200 DM for As, 300 Dm for BBBs, and 615 DM for BBs. Many new issue deals continued to utilize Sr./ Jr. AAA structures, allowing managers to price tighter on their senior AAA tranches and improving credit enhancement on deals. The spread widening did not stop managers from issuing deals as loan spreads continue to remain wide, keeping the arbitrage attractive. As such, estimates of 200+ warehouses make sense with many managers already pricing their seventh or eighth deal this year.

The AAA term curve remains steep with shorter dated refis pricing in the 90s DM. Tiering also is prevalent with Tier 1 5nc2 AAAs pricing between 113-116 DM and others in the low to mid 120s DM. Middle market (MM) issuance remains robust with four mid market deals pricing over the month. Although BSL spreads widened, MM AAA spreads tightened 2-3bps to 150 DM, showing strong investor demand for the asset class. Year to date mid market issuance stands at $10 billion.

CLO New Issuance

Source: TCW

Tier 1 New Issue Spreads (5nc2)

Source: TCW

New Issue BSL AAA DM – August 2021

Source: TCW

Technical Conditions– Loans

In August, institutional new issue declined 70% to $19.99 billion from the prior month’s issuance of $66.30 billion and was the slowest month since November 2020. As we look at the net forward calendar, we can see the primary calendar growing and is expected to be quite busy in the remaining four months.

Summary Institutional Loan Data – ($ in millions)

Source: Credit Suisse Distribution

Leveraged loan funds reported $2.2 billion of inflow in August with the loan asset class reporting inflows in 33 of the last 34 weeks. Average weekly inflows stand at $680 million, year-to-date. Inflows total +$5.0 billion quarter-to-date following +$13.6 billion of inflows in 2Q and +$14.1 billion of inflows in 1Q. AUM for loan funds now stands at $103 billion versus $69 billion at year-end and $154 billion in Oct-18.

LTM returns have continued to decline given the average price in the index and the rally that we saw post March 2020. The August spike in demand has contributed to the positive monthly returns in August and thus far in September.

Inflows vs. Returns

Source: LCD, an offering of S&P Global Market Intelligence

Fundamentals – Loans

Lagging 12-Month Default Rates

*Shadow default rate includes potential defaults, including those companies that have engaged bankruptcy advisors, performing loans with SD or D corporate rating and those paying default interest.
Source: LCD, an offering of S&P Global Market Intelligence

In August, the borrower Glass Mountain became the first creditor to default in the S&P LLI since February. There were no defaults in the previous five months, leaving the 12-month default tally for the S&P/LSTA at only 11. Retail/Restaurants (two defaults) and Oil & Gas (two defaults) led all industries during the period.

The default rate of the S&P/LSTA, by issuer count, dropped from 0.88% to 0.79% while the default rate based on par outstanding declined from 0.58% to 0.47%.

Fundamentals – CLOs

CLO fundamentals were mostly positive with WARF levels down over 20 points during the month and the percentage of defaulted assets remaining at zero. Annual default volume is amounting to one of the lowest levels we have seen post crisis with the YTD loan default rate at only 1.07%, according to JP Morgan. CCC/Caa exposure improved over the month with the percentage of CCC assets down 0.2% to 5.5% and % Caa assets down 0.3% to 4.7%. With the reduction in CCC/Caa assets, Jr. OC cushions increased another 10bps. Value metrics improved with loan prices up in August, boosting equity NAVs by 1 point to $60 and the percentage of loans trading over par to 13% vs 11% the month prior.

Valuation

Since 1992, the average 3-year DM for the CS LLI is 466bps. If the global financial crisis (2008 & 2009) is excluded, the 3-year discount margin for the CS LLI is 427bps. The 3-year DM finished the month at 447bps, which was 6bps tighter than the prior month.

The DM spread differential between Double Bs and Single Bs is 38bps tighter from September 2020 to August 2021 and 51bps tighter than the historical differential since inception.

3-Year Discount Margin Differential Between BBs and Single Bs

Source: Credit Suisse Leveraged Loan Index

CS LLI Snapshot

Source: Credit Suisse Leveraged Loan Index

Summary and Looking Forward

The story of August was the investment banks putting the brakes on syndications for the back half of the month and beginning of September while the syndication of CLOs provided the most robust monthly total ever. The average price in the JPM Index is now only $0.08 below the YTD high in mid-June ($98.65) and has nearly 20% of the Index trading above par.

With September, we are seeing primary launches in full swing. CS highlighted the expectations for the month below.

September Likely to See Busy Calendar

Source: Credit Suisse, LCD

Given the nature of loan syndications, which are typically 10-14 days before allocations, we would expect to see prices continue to grind higher until managers can reduce current cash positions.