Bank Loans: Room to Run Despite Rate Hikes

Fundamentals continue to look healthy in loans, and we expect investors will benefit from higher future coupons.

November 14, 2017


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

Loan market effective yields continue to inch higher as the three-month London interbank offered rate (Libor) rises due to Fed tightening and as refinancing activity slows. Although the Fed decided to forego a rate hike in September and November, three-month Libor rose that month from 1.31 percent to 1.34 percent as the market priced in a potential rate hike in December. Effective loan yields—the all-in coupon rate divided by the loan price—are now 4.8 percent, 0.2 percent higher than they were in July 2014 before the oil market selloff that set off an 18-month stress period for risk assets. Looking ahead, our Macroeconomic and Investment Research team’s expectations for rate hikes suggest that loan investors will gain from higher coupons going forward. We expect the Fed will raise rates four times in 2018, which is more than the market is currently pricing in.

Loan Yields Are Rising as Fed Tightens

Effective loan yields—the all-in coupon rate divided by the loan price—are now 4.8 percent, 0.2 percent higher than they were in July 2014 before the oil market selloff that set off an 18-month stress period for risk assets.

Loan Yields Are Rising as Fed Tightens

Source: S&P LCD, Guggenheim Investments. Data as of 9.30.2017. Loan effective yield = [three-month Libor + average contractual loan spread] / average secondary loan price.

The Credit Suisse Leveraged Loan index recorded a gain of 1.1 percent in the third quarter. Leveraged loan average contractual spreads and discount margins tightened by 12 basis points quarter over quarter, bringing them to 363 basis points and 432 basis points, respectively.

For floating-rate borrowers, rising short-term rates directly flow through interest expense. The question becomes whether or not the bank loan market can sustain more rate hikes from an interest coverage perspective. With interest coverage at 3.8 times, according to S&P LCD, our view is that the sector continues to look healthy. Our sensitivity matrix, which models interest coverage under a range of three-month Libor rates, suggests that if earnings stay flat, which is a conservative assumption, Libor would need to rise to 3.0 percent for coverage to fall to below 3.0x interest expense—a level that we believe is associated with weaker credits.

Interest Coverage Under Various Libor Scenarios

Our sensitivity matrix, which models interest coverage under a range of three-month Libor rates, suggests that if earnings stay flat, which is a conservative assumption, Libor would need to rise to 3.0 percent for coverage to fall to below 3.0x interest expense—a level that we believe is associated with weaker credits.

Interest Coverage Under Various Libor Scenarios

Source: S&P LCD, Guggenheim Investments. Data as of 9.30.2017. Assumes no change in earnings or contractual spreads.

—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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