Financial markets around the world are waking up to 2022 and scratching their collective heads in a fog. 2021 was a blur. Have we been on a fiscal stimulus bender? I went to Austria over the holidays and was struck as I looked out my hotel window to see the Vienna skyline littered with cranes. Now back in my seat in Los Angeles, I look out the window and while the view is considerably different than Vienna, it has one common theme – high-rise cranes.

Then I think about the equity markets – the NASDAQ composite having risen to over 16,000 in 2021 and the Dow Jones, which went above 36,000. This doesn’t seem like the natural result of a global pandemic. It isn’t just the global building activity or the record-setting equity markets that gives one pause. On the back of extremely low default rates – Leverage Finance, Bank Loans, HY Bonds, CLO Refinancing/Resets and CLO new issuance all broke records.

I am sure central banks around the world had nothing to do with it (hmm). Per David Mericle at Goldman Sachs, there was 6 cents on the Fed balance sheet for every dollar of GDP in Q2 2008. Just prior to COVID, this number had grown to 22 cents and now it stands at 37 cents. Unrelated…or related, Jamie Dimon said consumers are spending 25% more than they were pre-covid.

Dialing more directly into loans, the loan index grew 12% in 2021 with over $600 billion of institutional loan issuance. Issuance in 2021 was a full 20% larger than the previous annual record, set in 2017.

S&P/LSTA LL Index: Par Amount Outstanding and the Growth Rate

Data through December 31, 2021.
Source: Leveraged Commentary & Data (LCD); S&P/LSTA Leveraged Loan Index

The CLO market was up nearly 45% from the previous annual issuance record with $185 billion issued in 2021.

What does all this mean to loan managers? It likely means it is time to be very selective when picking credits. In the first half of 2018 (following a very busy 2017), the loan market raged with issuance and repricings. In 2019, we had many idiosyncratic stories of loans dropping more than 20 points due fundamental performance erosion.

We would be remiss not to mention benchmarks. After November exploded with record CLO issuance, December slowed to just $10 billion. Why did it slow? The SOFR/LIBOR transition is the simple answer. Any new issues priced in December had to close in December in order to be a LIBOR-based deal. Any deals closing in January had to be a SOFR-based deal. As a result, participants seemed to draw a hard line in the sand after the first ~10 days of the month and push all other new issue to 2022.

Performance – Loans

In December, the Credit Suisse Leveraged Loan Index (CS LLI) was up 0.63% and the S&P Leveraged Loan Index (S&P/LSTA) was up 0.64%. QTD returns for the CS LLI and S&P/LSTA were positive 0.71% and 0.75%, respectively.

For the 12 months ending December 31, the CS LLI was up 5.40% and the S&P/LSTA was up 5.20%.

In December, risk generally outperformed as triple Cs and single Bs led all categories with a 0.97% and 0.65% return. The exception to this was distressed loans which were the worst performing segment during the month. Split triple Bs and double Bs returned 0.50% and 0.60%. On a quarter-to-date basis, distressed loans and triple Cs lagged the broader index.

On an LTM basis, triple Cs and distressed loans outperformed all categories with 15.00% and 12.88% return, respectively. Meanwhile, double B loans and single B loans produced 2.96% and 5.11% returns.

Total Return by Rating

Source: Credit Suisse Leverage Loan Index

Sector Performance

In December, all 20 sectors in the CS LLI produced positive returns with the dispersion continuing to tighten between the top and bottom sectors. Only 83 basis points (bps) separated the two. Media/Telecommunications, Retail and Healthcare led all categories. The bottom performing sectors were Gaming/Leisure, Consumer Non-durables and Utility with total returns of 0.48%, 0.39% and 0.04%, respectively.

In the last 12 months, Energy, Metals/Minerals and Consumer Non-durable have led all sectors with total returns of 14.05%, 12.35% and 7.27%, respectively. Media/Telecommunications, Food/Tobacco and Utility provided the worst performing sector returns: 4.14%, 3.25% and 1.70%, respectively.

Industry Returns

Source: Credit Suisse Leveraged Loan Index

The average bid of the S&P LCD flow-name loan composite increased from 98.78 on December 2 to 99.23 by year-end. During the same period the broader CS LLI increased 27 basis points. As the loan primary dwindled in December, due in part to the LIBOR-SOFR transition, we saw bank loans remain better bid. And as is typical when supply dries up, loans pushed higher to end the year. Driving the demand was a combination of recently ramped CLOs as well as inflows from retail funds. As the discussion surrounding rate hikes in 2022 becomes more and more amplified, there seems to be a greater depth of bank loan buyers.

Average Loan Flow-Name Bid

Source: Leveraged Commentary & Data (LCD)

Performance – CLOs

CLO performance was flat in December as light supply in primary and secondary caused spreads to remain rangebound. CLOs returned 0.1% during the month, the third lowest monthly return during the year. CLOs outperformed IG (-1.08%) and underperformed HY (+1.87%) and Loans (+0.64%). For 2021, CLOs returned 2.37%, outperforming IG (-1.08%) and underperforming HY (+5.28%) and Loans (+5.2%). Annual CLO returns in 2021 were the lowest since 2018.

AAA spreads were flat to slightly wider over the month on limited supply. AAA BWIC volume was $1.1 billion in December, almost half of November’s volume. Although discount prices on AAA bonds were attractive, many investors had closed their books for the year and thus balanced supply/demand dynamics caused little movement in spreads. Year-over-year AAA spreads are 5-10 bps tighter as increased demand from many investors kept the tranche in high demand despite the heavy supply.

AA spreads were also flat over the month with very little trading activity going through. Spreads remained in the 150-180 Discount Margin zone, unchanged from November. Year to date AA spreads were flat, the only tranche within the CLO stack to not tighten over the year.

Single As were also flat over the month with less than $100 million in BWIC activity occurring in the tranche during December. Spreads ended the year in the high 100s/low 200s DM, 15 bps tighter vs. the end of 2020. Single As were attractive to insurance companies throughout the year given the higher spread and attractive capital treatment; however, this may change next year due to revised NAIC capital charges that would favor AAA investments over single As.

BBB was the only tranche to tighten over the month with spreads 3-5 bps tighter, but still not fully re-tracing its November widening. BBB was also the only tranche to see a pick-up in BWIC activity from November. BBB spreads over the year tightened 25 bps as asset managers found the tranche attractive given the wider spread relative to the commensurate risk.

BB spreads were 10 bps wider month over month as looming Omicron concerns and year-end liquidity caused spreads to weaken. Lower MVOC and less-sought-after names experienced the brunt of the widening with spreads on those bonds remaining in the 700s-800s DM. Year to date, BBs are 25 bps tighter as MVOCs improved, defaults declined and the economy improved.

Equity trading was very limited in December, however higher loan prices boosted NAVs to further bolster total returns for the year. CLO equity had a banner year with median returns in the +30-35% range, the second highest post-crisis annual return. Higher NAVs and robust quarterly payments due to LIBOR floors, low cost of debt and par gains from 2020 purchases were the main drivers behind returns. In addition, secondary liquidly in equity vastly improved as more buyers entered the asset class and trade volume reached new highs with $3.7 billion in BWIC activity, double that of 2020 and almost triple the volume from 2019.

As mentioned, secondary volume was lower in December vs. November. Total BWIC activity was $2.4 billion, 45% lower m-o-m. Total volumes per TRACE were $9 billion, a 10% decline from November led by a 30% drop in Non IG volume. Total TRACE volume for 2021 was $136 billion, a 24% decline from 2020 largely due to a decrease in IG traded volume.

Secondary CLO 2.0 Total Returns

Source: J.P. Morgan CLOIE Index

Secondary CLO 2.0 Spreads (DM)

Source: TCW

Technical Conditions – CLO Primary

Capping off the highest year on record in CLO issuance, the CLO primary market had a busy start in December with $10 billion of new issues across 15 deals. Issuance was concentrated in the first two weeks of the month so that deals could close before the SOFR transition in 2022 with the last new issue pricing on December 17. Given that most loans are benchmarked to LIBOR, managers were attempting to avoid basis risk by pricing LIBOR-based CLOs in 2021. Basis risk will be introduced in 2022 as SOFR deals begin to price, with current exposure to SOFR loans in broadly syndicated loan (BSL) CLOs standing at only 0.5% at the end of December. We continued to see some spread widening with heavy issuance volumes and market volatility due to the Omicron variant with AAAs widening 1 bp and BBs widening 10 bps. The rest of the stack was flat on the month, leaving spreads for tier 1, full duration AAAs at 115 DM, AAs at 165 DM, As at 200 DM, BBBs at 300 DM, and BBs at 635 DM. The AAA term curve flattened slightly with the middle of the curve (2-year reinvest) widening to 100-112 DM over the month, as issuers became more price insensitive in order for their deals to cross the finish line. Longer deals continued to price in the 113-120 DM range.

Full year new issuance in 2021, bolstered by record loan issuance and CLO demand, reached a whopping $185 billion in December, shattering the previous yearly issuance record of $127 billion in 2018. In addition, a record 128 managers issued deals in 2021, including 12 first time managers. In spite of record issuance, primary spreads tightened across the stack. Year over year, primary tier 1 AAAs, AAs and single As were 5 bps tighter and BBBs and BBs 50 bps tighter.

Refi/reset volumes remained robust despite lower issuance volumes overall with $5.1 billion in refis and $6 billion in resets pricing over the month. Refi/reset volumes also set issuance records in 2021 with total refi volume hitting $109.3 billion and reset volume hitting $135.5 billion. Higher refi/reset volumes can be attributed to many 2017- and 2019-vintage deals nearing or exiting their non-call and reinvestment periods throughout the year, as well as 2020-vintage, shorter-dated deals, issued in the height of the pandemic, being repriced by managers. The total refi/reset volume of $245 billion in 2021 was over $200 billion greater than 2020 full year volume of $31 billion.

Middle market (MM) issuance was robust with five deals pricing in December for a total of $3 billion in new issue. Spreads have remained relatively flat for 4 year reinvest 2 year non-call MM deals with AAA levels ranging from 145-160 DM. Demand for MM CLOs remains strong due to their wider spreads, higher credit enhancement and improving fundamentals. Full year middle market issuance for 2021 reached a record $20.6 billion in December, 25% higher than the previous record reached in 2018 of $16bn.

Technical Conditions – Loans

CLO New Issuance

Source: TCW

Tier 1 New Issue Spreads (5nc2)

Source: TCW

New Issue BSL AAA DM – December 2021

Source: TCW

As 2022 begins, the net forward calendar is a mere $3.4 billion following a prolific year of issuance. Both loan issuance and CLO issuance is slow out of the gates as borrowers, lenders and investors all get more comfortable with SOFR based deals, the SOFR-LIBOR basis adjustment and the potential mismatch between the collateral and the liabilities.

Summary Institutional Loan Data ($ in millions)

Source: Credit Suisse Distribution

Leveraged loan funds reported $3.2 billion of inflows in December with the loan asset class reporting only three outflows in the last 52 weeks. AUM for loan funds is now over $119 billion as compared to $69 billion at year-end 2020 and to the peak assets under management mark of $154 billion set in October 2018. Inflows for loan funds totaled $46.5 billion 2021 following outflows in 2020 totaling -$27.0 billion.

Returns post March 2020 have largely been retracing the pandemic losses in February and March of 2020. LTM returns have begun to flatten and approach coupon returns as the average price in the index approaches par.

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

There were no defaults in December and only five in all of 2021. There has been one default each in Information Technology, Telecom, Oil & Gas, Textile & Apparel and Retail.

The default rate of the S&P/LSTA, by issuer count, remained flat at 0.44% while the default rate based on par outstanding was also constant at 0.29%.

Fundamentals – CLOs

CLO fundamentals were mostly improved in December with WARF levels continuing to decline to 2,792. WARF levels have declined 330 points since December 2020, which reflects a lower exposure to riskier loans in CLOs. The percentage of defaulted assets remains at zero and CCC/Caa exposure declined 30 bps/10 bps month over month, bringing CCC/Caa exposure down by 3% during 2021. Junior OC cushions also improved 10 bps over the month with the reduction of CCC/Caa assets and currently stands at 430 bps, over a 130 bps improvement from the beginning of the year. Value metrics improved as well with median equity NAV up 60 bps to 62.1 and BB MVOC at 107. Equity NAVs improved over 15 points year over year commensurate with loan prices increasing 1.3 pts during 2021.

Valuation

Since 1992, the average 3-year DM for the CS LLI is 466 bps. If the global financial crisis (2008 & 2009) is excluded, the 3-year DM for the CS LLI is 427 bps. The 3-year DM finished the month at 439 bps, which was 12 bps tighter than the prior month.

The DM spread differential between Double Bs and Single Bs is 30 bps tighter from January 2021 to December 2021 and 63 bps 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

While Omicron has impacted ‘recovery’ names and news headlines, it does not feel like the markets are as concerned about the variant. However, as we begin January, all eyes seem to be focused on rates, inflation and the subsequent impact on fixed income. Beyond the concern surrounding duration, risk has generally been better for sale. While equities and broader fixed income markets have been selling off, loans are still grinding higher.

The delay in CLO issuance has not provided an impediment to loans. Inflows to floating rate funds, reallocation from crossover buyers to loans as well as continuing ramp activity from over 200 warehouses have all managed to provide a solid bid for loans to start the year.

Interestingly, nearly 60% of the loan market carries a LIBOR floor, essentially mitigating the near term benefit of rising rates. Having said that, the loan market saw this same issue in 2013 and investors ignored the floor component of the coupon and prices essentially behaved as if the asset class was truly floating rate. As we head into a year where rates are set to rise, we would expect to see funds flow into the retail asset class as well as the CLO market.