In our series on portfolio construction [link] we looked at how liquid and illiquid loan managers assemble quality all-weather assets. Because of the contrasting characteristics and behaviors of BSL and middle market, PMs work differently to extract and maintain value.

In recent months, thanks to market volatility caused by higher interest rates, toppy inflation, and the perceived higher probability of a recession, large cap loan prices have traded down sharply. S&P/LCD’s leveraged loan index has dropped from 98.5 in February to 92 last week.

While an economic downturn would certainly increase the probability of loan defaults and losses, history shows that BSL default rates barely amounted to 8% in the Great Recession, let alone losses. So at this stage in the credit cycle, 92 represents the “worry discount” from perceived higher credit risks, particularly in sectors such as energy, food and commodities.

But that discount has real impact on primary issuance. To compete for buyers in the secondary market, the resulting average yield of a new single-B term loan has doubled from 4% to 8% since last fall. What’s good for BSL investors, of course, is a drag for issuers. Large cap volume, per S&P/LCD, is off about 50% from last year. High-yield bond issuance has dropped off 75%.