Bank Loans: Refi Activity Takes a Breather

The share of loans trading above par has declined from the peak earlier in the year, easing some refinancing pressure.

August 16, 2017


This Bank Loans sector report is excerpted from the Third Quarter 2017 Fixed-Income Outlook.

After 15 consecutive months of net supply shortage, June saw a significant increase in net supply relative to inflows from mutual funds and CLOs. The U.S. leveraged loan supply/demand balance saw a supply surplus of $22 billion, compared to an average shortage of $7 billion since March 2016. The surplus in supply translated into weaker performance for the overall market, with the share of loans trading above par declining to 46 percent of the Credit Suisse Leveraged Loan index from 62 percent in February, culminating in the first monthly loss for the index since February 2016. On a positive note, the decline in loans trading above par has eased refinancing activity which dropped to 34 percent as a share of total institutional loan issuance in June, the lowest since May 2016.

Bank Loan Supply Exceeded Demand

The U.S. leveraged loan supply/ demand balance —net loan supply minus visible inflows—saw a supply surplus of $22 billion, compared to an average shortage of $7 billion since March 2016.

Bank Loan Supply Exceeded Demand

Source: S&P LCD, Guggenheim Investments. Data as of 6.30.2017.

The Credit Suisse Leveraged Loan index posted a 0.06 percent loss in June, but still gained 0.8 percent in the second quarter of 2017 as three-year discount margins tightened by 2 basis points quarter over quarter. This makes it the sixth consecutive quarter of positive returns in the loan market. Lower-quality loans underperformed higher-quality loans, with CCC loans losing 0.4 percent, versus gains of 0.7 percent and 1.1 percent for BB-rated loans and B-rated loans, respectively.

We remain positive on bank loans over the medium term as the fundamentals point to a continuation of lower-than-average default rates. The average interest coverage of loans outstanding is 4.3x based on the arithmetic average and 3.8x when weighted by issue size. Looking at historical data, we find that interest coverage below 3x is consistent with an uptick in defaults. Assuming earnings remain unchanged, the London Interbank Offered Rate (Libor) would have to increase to 3.0 percent for interest coverage to fall below 3x.

Loan Default Rate Remains Well Below Historical Average

We remain positive on bank loans over the near- and medium-term as the fundamentals point to a continuation of lower-than-average default rates.

Loan Default Rate Remains Well Below Historical Average

Source: S&P LCD, Guggenheim Investments. Data as of 6.30.2017.

—Thomas Hauser, Senior Managing Director; Christopher Keywork, Managing Director

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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