KKR is out with a new credit focused letter. The summer lull seems to be real among the authorship. KKR’s note is a wandering comparison of credit markets to Hemingway’s A Sun Also Rises. And they do a fairly decent job of that far reaching parallel. Kudos.
I didn’t find the entire note to be particularly full of insight, more a check in of where we are in credit markets, but it’s useful for me. Let’s get to the interesting parts:
The late July rally in high yield and increased appetite for risk assets is a great example of why we are paying close attention to the total return opportunity in the credits we like as spreads compress quickly when the market decides to move. Bids for liquid credit re-emerged in late July, sending spreads tighter by ~100bps off their wides and high yield is now up +6.02%34for the month of July — its best month in 11 years. Notably, BB’s closed out the month up 6.23%,35 outperforming CCC risk by 134bps. It is of note that this rally is heading into the depths of corporate earnings. Similarly, the loan market was up +2.1% as of July 31st, which has been its largest move since November 2020. July’s resilient CLO demand of $9 billion coupled with a decade low for new issue supply of $2.2 billion36 has been supporting technicals for positive price action. The recent activity has helped us get more comfortable that there may be a floor to additional dramatic downside risk as we are now starting to see pools of capital stepping into risk providing stability, albeit feeling leadership-less.
The question going forward, obviously, is will there be another leg down?
Interestingly, KKR discussed how liquidity constraints can make a market opportunity frustratingly unavailable for large players:
Ultimately, the invisible strain to this market’s volatility has been the lack of liquidity. We have discussed many times how critical liquidity is during market drawdowns. Thin liquidity not only affects the pricing of assets but also the ability to execute. While the market has had a number of sharp moves this part quarter, we saw muted volumes. This was not a scenario of a contained bull fight in a ring, but rather bulls running the streets wild and as a result, required true patience. There are long-term opportunities swimming in the market but there has been a lack of the market-depth needed to take full advantage of them. The street has been remiss to provide new capital given underwriting and risk limitations are already at a constraint for the year, which has in turn re-directed deal activity and also echoed caution across all market participants.
I have seen echos of this elsewhere, with Ladder Capital being one:
And as far as security, I would love to add a lot of securities where they’d be pricing in the last months, but I don’t think we’re going to be able to, I get $100 million to $200 million, but I don’t think we’re going to be able to buy a large amount of AAA bonds that are yielding 21% [levered return].
LADR Q2-2021 Earnings Transcript
Alas, here is where we are in US credit as of today:
