About this episode:
2021 saw favorable conditions in the credit market. Will this continue in the new year? In this episode, Kara O’Halloran, Director, Investment Research and Rob Hoffman, Head of Investment Research, explore the potential impacts to credit markets in 2022. Plus, hear Rob’s take on the best opportunity in credit right now (hint: it’s CLO’s).
Kara O’Halloran (00:06):
Welcome back to Fireside a podcast from FS Investments. My name’s Kara O’Halloran and I’m a Director on our Investment Research team here and on today’s episode we are continuing with our 2022 outlook content this time focused on credit markets. I have brought in Rob Hoffman, the Head of our Research team and our resident credit expert to talk about the five big things that we are watching in credit next year. Rob, welcome. Thanks for joining.
Rob Hoffman (00:31):
Yeah, thanks for having me great to be here.
Kara O’Halloran (00:32):
Yeah, of course. so I would say I want to dive right in but as a podcast host, I think I’m legally obligated to have a really long meandering question. So thinking about 2021, I felt like a broken record at times talking about credit markets, which I don’t think is a bad thing coming into the year we basically called for spreads to tighten to post global financial crisis levels, which they did in high yield and they came close in loans. They’ve come off of those tights a little bit in recent weeks but still sitting at pretty tight levels, we thought default rates would fall, they have, they’re below 1% in both markets. We thought fundamentals would continue to improve and they did, so basically my question is, how did we get all this so right? No, I’m kidding. But no, so I want to talk about 2022, as I said, “Spreads are tight”. Where do you think they can go from here?
Rob Hoffman (01:24):
Yeah, look the past couple weeks, few weeks have brought us this… Almost the first bout of real volatility that we saw in the year and one of the things that was really interesting is, I think the equity markets saw more volatility than high-yield and credit. If you look at small cap stocks and how they performed vis-à-vis high-yield, high-yield held in really well and I think a core part of that and really what was one of the core parts of our calls for 2021 was just a strong, AKA low default environment and a strong fundamental environment for credit that really helps anchor high-yield bonds and loans from an index perspective. I think as we look into 2022, to expect a low default rate to continue, high-yield spreads average below 350, loans, which are maybe just a hair over 400 right now could very easily average below 400.
Rob Hoffman (02:25):
I think those are conditions that are fairly consistent with strong, low default rate environments. We have examples of this in history, December of 94 to July of 98, December of ’03 three to June of ’07. These are each three and a half year long periods of time with default rates that are sub 2% let alone the environment we’re in now where we’re sub 1% where default rate or spread levels can very much average, these levels that we just talked about for almost the duration of those periods of time. So not that we may not get a little bout of volatility here or there in 2022. Sure enough we definitely will but I think as we think about the year as a whole, if we expect these favorable credit conditions to continue, I think spread levels are going to stay fairly low, fairly tight, because what’s going to push them wider? What’s going to change that real fundamental backdrop?