Credit market commentary

Credit market commentary: March 2021

Interest rate volatility continued to weigh on markets for much of the month.

April 7, 2021 | 5 minute read

Data as of March 31, 2021, unless otherwise noted.

Performance (total returns)

BenchmarksMarch 2021YTD
Bloomberg Barclays U.S. Aggregate Bond Index (Barclays Agg)-1.25%-3.37%
ICE BofAML U.S. High Yield Master II Index (HY Bonds)0.17%0.90%
S&P/LSTA Leveraged Loan Index (Senior Secured Loans)0.00%1.78%

Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

Leveraged credit’s climb stalled slightly in March: HY Bonds eked out a slight gain as a surge on the last trading day of the month put the asset class back in positive territory after declining for much of March. Senior Secured Loans ended the month flat, ending an 11-month streak of gains. The interest rate volatility that began in late February continued for much of March, causing periods of risk-off sentiment which weighed on credit markets. The search for yield appears paramount this year as the riskiest assets have continued to outperform. CCCs are now outperforming BBs in both markets by over 500 bps YTD, and second-lien loans have outperformed first-liens. HY Bonds saw record issuance in March and loan issuance volume for the first quarter also eclipsed previous levels. We believe that given this heightened issuance, many companies are well capitalized, having shored up liquidity and extended debt maturities. The overall technical picture in the HY market remains one of excess supply as retail outflows have continued, but rising stars have helped balance the picture somewhat. The loan market has seen strong demand from both retail and institutional investors, as the CLO primary market is off to its busiest start since the Global Financial Crisis (GFC). The fundamental backdrop for credit remains favorable. The passage of the $1.9 trillion stimulus package boosted GDP forecasts significantly, default rates were sent sharply lower last month, and ratings upgrades continue to outpace downgrades. The volatility in long-term interest rates sent the duration-sensitive Barclays Agg sharply lower, down -1.25% in March and -3.37% YTD.

One year after the market low, credit still has room to run: Spreads for HY Bonds and Senior Secured Loans have surpassed their pre-pandemic tights and are rapidly approaching post-GFC lows, prompting questions about just how low spreads can go. By ratings mix, the HY market has improved in quality in recent years while the quality of the loan market has deteriorated. All else equal, a higher-quality market should demand less spread compensation. In our view, given the strong economic backdrop and relative weighting of higher-quality assets, it is not unreasonable to think that HY Bond spreads could approach their all-time tight levels. BB rated bonds now make up over half (55%) of the high yield market while CCC rated bonds comprise just 12%. This compares to the loan market, where B rated issues make up the lion’s share at 57% while BB rated loans make up roughly 25%. This increase in B rated loans is largely driven by increasing loan-only issuance—loans to companies without subordinated bonds in their capital structures to act as a buffer for loan holders in the event of credit problems. Recovery rates for loan-only issuers that have defaulted over the past year is just 43%, compared with 59% for companies with both bonds and loans. We do believe that there can be idiosyncratic opportunities in the loan market, but experienced, active managers are best positioned to discern given this worrisome issuance trend.

Key takeaways

  • Interest rate volatility continued to weigh on markets for much of the month.
  • HY Bonds eked out a positive return while Senior Secured Loans ended March flat.
  • The duration-sensitive Barclays Agg continued to struggle, ending down -1.25%.

Index descriptions: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). ICE BofAML U.S. High Yield Master II Index is designed to track the performance of U.S. dollar-denominated below investment grade corporate debt publicly issued in the U.S. domestic market. S&P/LSTA Leveraged Loan Index is a market value-weighted index designed to measure the performance of the U.S. leveraged loan market.

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This credit market commentary and any accompanying data is for informational purposes only and shall not be considered an investment recommendation or promotion of FS Investments or any FS Investments fund. The credit market commentary is subject to change at any time based on market or other conditions, and FS Investments and FS Investment Solutions, LLC disclaim any responsibility to update such credit market commentary. The credit market commentary should not be relied on as investment advice, and because investment decisions for the FS Investments funds are based on numerous factors, may not be relied on as an indication of the investment intent of any FS Investments fund. None of FS Investments, its funds, FS Investment Solutions, LLC or their respective affiliates can be held responsible for any direct or incidental loss incurred as a result of any reliance on the credit market commentary or other opinions expressed therein. Any discussion of past performance should not be used as an indicator of future results.

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