October continued the trend of significant CLO and loan demand offset by material loan issuance. CLO issuance year-over-year is up over 200%. In fact, the last three months of CLO supply has surpassed annual CLO issuance 10 of the last 20 years. Institutional loan supply declined -29% to $50 billion from September but it is important to note that September represented the third largest monthly issuance in loan market history. Year-to-date activity has been enormous and year-over-year new issue loan volume is up near 125%. October prices were flat to slightly down as the market was still digesting September’s issuance when October posted another solid month.

With the specter of inflation hovering around financial markets, demand for floating rate products has continued to drive loan performance. As a result, loans have posted very strong results year-to-date.

Loan Returns Lead Other Credit Asset Classes

Source: Credit Suisse

At the beginning of November, approximately 25% of the loan market traded above par with 64% of the index trading between 98-100.

Performance – Loans

In October, the Credit Suisse Leveraged Loan Index (CS LLI) was up 0.24% and the S&P Leveraged Loan Index (S&P/LSTA) was up 0.27%. YTD returns for the CS LLI and S&P/LSTA are positive 4.90% and 4.70%, respectively.
For the 12 months ending October 30, the CS LLI was up 8.53% and the S&P/LSTA was up 8.47%.
In October, triple Cs and distressed loans pulled back and underperformed the broader market. Single Bs outpaced double Bs and Split triple Bs. Conversely, on a year-to-date basis, triple Cs and distressed loans outperformed all categories with 14.80% and 14.46% returns, respectively. Double B loans and single B loans produced 2.51% and 4.53% returns.
On an LTM basis, risk outperformed as triple Cs led all categories with a 25% return. Single Bs produced a 7.83% return and double Bs returned 5.20%.

Total Return by Rating

Source: Credit Suisse Leverage Loan Index

Sector Performance

In October, 19 sectors in the CS LLI produced positive returns. Media/Telecommunications was the sole sector to produce a negative return with sector returns weighed down by a few distressed performers. Dispersion declined slightly between the top performing sector and the bottom performing sector with 96 basis points (bps) separating the two. Metals/Minerals, Utilities and Energy led all categories. The bottom performing sectors were Healthcare, Consumer Non-durables and Media/ Telecommunications with total returns of 0.04%, 0.02% and -0.08%, respectively.

In the last 12 months, Energy, Metals/Minerals and Aerospace have led all sectors with total returns of 21.11%, 17.40% and 14.12%, respectively. Financial, Food/Tobacco and Utility provided the worst performing sector returns: 5.89%, 5.81% and 4.11%, respectively.

Industry Returns

Source: Credit Suisse Leveraged Loan Index

The average bid of the S&P LCD flow-name loan composite decreased from 99.36 on October 7 to 99.27 on November 4. During the same period the broader CS LLI decreased -7 bps. With over 120 CLO warehouses open at a single large trustee and a surge of CLO repricing and reset activity, October demand was able to digest $50 billion of new issue after the $70 billion print in September.

Average Loan Flow-Name Bid

Source: Leveraged Commentary & Data (LCD)

Performance – CLOs

CLO performance in October continued its steady pace from the last few months with new issuance and secondary volumes still high but demand readily available to absorb the supply without moving spreads materially. In fact, spreads were slightly tighter over the month, especially down the stack. In addition, as rates continued to back up, CLOs and loans garnered more interest and outperformed over the month vis-a-vis other asset classes. CLOs returned +0.20% in October, outperforming HY (-0.17%), underperforming Loans (+0.27%) and on par with IG (+0.22%). Year to date, CLOs are returning +2.25%, outperforming IG (-1.09%) and under-performing HY (+4.36%) and Loans (+4.70%).

In a recurring theme, the top of the CLO stack was unchanged over the month as demand remained elevated and CLO prices were capped at a slight premium to par due to callability. AAAs remain well bid in secondary and an $830mm AAA bid list during the month was a testament to that demand. The list went very well with all bonds trading at a premium and covers averaging ~100 discount margin (DM). There were multiple client bids and dealers ended up buying a third of the list. The trading volume and demand at those levels was a great demonstration of the liquidity that is available on CLO AAAs with block sizes trading on such short notice at such strong levels in light of the high supply in primary.

AAs were also very well bid over the month, with even recently issued 2021 vintage AAs trading inside new issue levels in the 150s DM. BBBs and BBs were 5-10 bps tighter as demand for shorter, discount bonds was evident with covers in the mid-tohigh 200s and mid-to-high 500s DM, respectively.

Equity trading picked up significantly with over $550 million in BWIC activity. Given October is a payment date month, many investors were looking to sell their equity positions after clipping their October payment and monetize high NAVs. CLO managers also looked to sell to raise cash and re-deploy that cash into the equity of their new deals. As per Kopentech (CLO data provider), YTD equity BWIC volume is now $4.5 billion, up 55% YTD vs. 2019 and 2020, both at $2.6 billion. CLO equity payments were also very strong with a 15 bps increase in median payments to 3.9%. The LIBOR floor benefit along with wider new issue loan spreads and high first payments from 2021 deals partially drove the increase.

Overall trading activity doubled from September to $3.7 billion and $13 billion overall volume per TRACE. IG trading rose over 80%, some of the largest IG volumes we have seen since earlier this year. Dealers got net longer in IG and non-IG over the month by almost $1 billion from the heavy AAA and equity 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

The CLO primary market continued to out-do itself in October by issuing a record-breaking $19.5 billion in new issuance across 35 deals, beating out the previous monthly issuance record of $19.4 billion in August of this year. The upcoming LIBOR transition was at the forefront of everyone’s mind as managers were in a mad dash to issue their last LIBOR-based deals prior to the transition to SOFR in 2022. For the same reason, refi/reset volumes were also robust with $8.2 billion in refi volume and $16.1 billion in reset volume pricing over the month. YTD issuance reached $149 billion in October, yet again beating out projections and keeping issuance on track to hit or even exceed the 2021 new issuance projection estimates of $160 billion.

In spite of the heavy volume, CLO spreads on top tier 5nc2 new issue deals remained surprisingly flat for AAAs-As and even 5 bps to 10bps tighter in BBBs and BBs, ending out the month with AAAs at 113bps, AAs at 160 bps, As at 195 bps, BBBs at 295 bps, and BBs at 615bps. Nearly a quarter of October deals utilized a Sr./Jr. AAA structure, allowing managers to execute tighter prints on senior tranches and improve credit enhancement. The CLO arb remains attractive with range-bound liability pricing and primary loan spreads remaining wide. With effective WAS increasing by 3bps over the quarter, combined with lower liability costs due to refis and resets, median CLO equity payments remain very robust. The attractive arb, low default environment and high quarterly cash on cash payments have increased the demand for CLO equity and as a result, the number of open CLO warehouses is estimated to be over 200.

In another “first”, the first SOFR-backed CLO tranche priced over the month. The tranche was issued off of a reset transaction with a three year reinvestment period and one year non call. The AAAs were split into LIBOR and SOFR based notes. The LIBOR-linked tranche priced at L + 109 with the SOFR-based tranche at S + 124, implying a 15 bps spread adjustment on the SOFR tranche. The deal set a benchmark for shorter dated deals (three year reinvestment period) with the 15bp spread adjustment, but for the five year reinvestment period / two year non-call that has been the standard for new issue CLOs, the spread adjustment is expected to be higher due to the longer expected WAL. Assuming loans and CLOs continue to adopt similar spread adjustments, CLO equity basis risk should remain range bound.

The AAA term curve remained steep with shorter refis continuing to price in the 90s DM and longer deals in the 113-120 DM range. Middle market issuance has remained robust with five deals pricing over the month totaling $3 billion. Middle market AAA spreads remained flat at 150 DM with some deals looking to price inside of that in November. Year to date middle market issuance currently stands at $13.8 billion, handily exceeding 2020 issuance volume of $11.3 billion.

CLO New Issuance

Source: TCW

Tier 1 New Issue Spreads (5nc2)

Source: TCW

New Issue BSL AAA DM – October 2021

Source: TCW

Technical Conditions – Loans

In October, we saw the net forward calendar decline to $10 billion following the spike in September. November and December are expected to follow traditional syndication patterns where we see quite a busy calendar activity until Thanksgiving and a final surge of primary issuance post-Thanksgiving before essentially closing down for the last two weeks of 2021.

Summary Institutional Loan Data ($ in millions)

Source: Credit Suisse Distribution 

Leveraged loan funds reported $3.9 billion of inflows in October with the loan asset class reporting inflows in 42 of the last 43 weeks. AUM for loan funds is now over $111 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 total $39.8 billion YTD 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 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 loan defaults in September or October and there have been only three defaults during 2021. There have been four defaults during the last 12 months and the industries represented include: Oil & Gas, Real Estate, Retail, and Textile & Apparel.

The default rate of the S&P/LSTA, by issuer count, dropped from 0.44% to 0.35% while the default rate based on par outstanding declined from 0.47% to 0.32%.

Fundamentals – CLOs

CLO fundamentals were mostly improved month over month with WARF levels down 15 points as the percentage of defaulted assets remained close to zero. CCC/Caa exposure was down another 20bps over the month with the current percentage of CCC assets sitting at 5.1% and the current percentage of Caa assets at 4.3%. Jr. OC cushions continued to improve with the reduction in CCC/Caa assets and levels are very close to approaching pre-COVID levels. Value metrics improved over the month with median equity NAVs up 2 points to $67 and BB MVOCs by 30 bps to 107%.

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 discount margin for the CS LLI is 427 bps. The 3-year DM finished the month at 440 bps, which was 1 bps wider than the prior month.

The DM spread differential between Double Bs and Single Bs is 26 bps tighter from November 2020 to October 2021 and 49 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

Demand for loans continues to be driven by CLO demand and in November, CLO issuance appears to be tracking at a historically high rate. As the market transitions to SOFR, we are told that banks will have little effective demand for LIBOR based CLO liabilities in December. Consequently, November is seeing a push in the last of the LIBOR denominated deals.

Loan prices are pushing higher after October prices drifted lower. Loans are being pushed higher by what looks to be the largest CLO monthly print of 2021. While the road map for November seems to be pretty clear, there is more uncertainty to what December will bring. What will be the CLO demand in December in a SOFR based world? Was December’s demand pulled forward and have bank budgets for CLO liabilities been met? Time will tell but regardless of what happens in December, this has been a historical year for volumes both from CLO issuance and institutional loan issuance.