January 5, 2022 - Despite several COVID-induced fits and starts, particularly in the fourth quarter, risk assets enjoyed a strong year in 2021 as investors were paid well by trading down the capital structure.  As the US economy grew over 10% nominally in 2021, inflation spiked alongside higher treasury yields.  At the same time, risky asset and commodity prices ran higher, which resulted in some very strong performances (oil rallied 50%).  To wit, the S&P 500 returned north of 28%, while the S&P/LSTA Leveraged Loan Index (5.2%) and the Bloomberg High Yield Bond Index (5.4%) were the major beneficiaries of yield-starved fixed income investors.  In comparison, the Bloomberg US Aggregate lost 1.5%, its first negative reading since the taper tantrum of 2013.

In looking back at the 2021 loan market, several noteworthy trends emerged alongside a number of record-breaking events; these combined would go on to lift secondary loan prices to multi-year highs.  Paramount to the price gains was a dramatic improvement in credit quality, reflected by upgrades beginning to outpace downgrades in February 2021.  Over this 11-month period, a total of 653 upgrades took place, compared to 346 downgrades.  In other words, for every downgrade, there were 1.9 upgrades.  In turn, the default rate dropped 355 basis points to 0.29% by year-end, or just 13 basis points short of its all-time low.  Given this much improved credit environment, it is not all too surprising that lower rated credits and/or distressed loans (priced below 80 cents on the dollar) outperformed.  According to Citi Research, distressed loans led with a 15.9% return, followed by second lien loans (+9.9%) and B-/CCC loans (+8.3%).

While credit trends supported a risk-on mentality across 2021, supply and demand levels reached record proportions.  On the supply side, record lending activity, particularly in M&A transactions, drove a 12% growth rate (+$148B) in S&P/LSTA Leveraged Loans (LLI) outstanding, which ended the year at a fresh record of $1.35T.   Fueling that growth was a tremendous year for CLO issuance.  According to LCD, the record $56B in fourth quarter CLO issuance accelerated what was already an unprecedented year in deal-making for this essential source of demand for leveraged loans. In total, 2021 CLO issuance hit a record $187B, which not only doubled last year’s tally but also outpaced 2018’s previous high of $129B. At the same time, 2021 retail loan investors flocked to the floating-rate asset class at a pace not seen for several years. (In fact, annual flows had been negative since 2018.) Net inflows occurred during 48 of the 52 weeks of 2021, totaling a massive $33.9B (a stark contrast to investors withdrawing $19B in 2020).  

Considering that CLO issuance ($187B) alone grossly outstripped the rise in LLI outstandings ($148B), it made perfect sense that traders bid up the secondary in order to put dollars to work in 2021.  Across the year, average bid levels increased 225 basis points to a three-year high of 98.64, while the median price point increased 70 basis points to 99.53, or just 47 basis points short of par value.  Higher prices of course, were accompanied by tighter spreads; the average bid-ask spread tightened 43 basis points in 2021, to “just” 75 basis points.  

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