Sympathetic Widening Yields Opportunity

Bank loan valuations weakened in sympathy with the high-yield bond market, but we believe investors are being well-compensated for credit risk.

March 17, 2016


This sector report is excerpted from the First Quarter 2016 Fixed-Income Outlook.

Bank loan discount margins, moving in sympathy with high-yield bond spreads that suffered from declines in oil prices, widened by 88 basis points in 2015 to 643 basis points, the widest since 2011. The saving grace for loans is that with only 2.9 percent exposure to energy, and 1.5 percent to metals and minerals, they should remain insulated from the credit troubles faced by high-yield bonds. Analysis by our Macroeconomic Research Team, however, suggests continued volatility, at least through the second quarter of 2016.

Primary Market for Institutional Loans, by Investor Type

CLOs have historically served as a stable source of demand for bank loans, evidenced by their 56 percent average market share of the primary loan market between 2002 and 2015 (excluding bank participation). We expect this source of demand to ease in 2016 but remain positive, offsetting bank loan mutual fund outflows.

Primary Market for Institutional Loans, by Investor Type

Source: S&P LCD. Data as of 12.31.2015. Market share calculations exclude bank participation.

The bank loan market ended 2015 with a total return of -0.4 percent, the first loss since 2008, based on the Credit Suisse Leveraged Loan index. It was only the second negative year for the asset class since performance data became available in 1994. Mutual fund investors withdrew roughly $16 billion from the market in 2015, but a robust primary market for CLOs somewhat offset outflows. CLOs have historically been a stable source of demand for bank loans. We expect this technical support will ease in 2016, but it should remain positive.

Our view is that bank loan investors are being well-compensated for risk. Despite ongoing volatility, we believe solid credit and growth fundamentals will support the loan market. Average interest coverage ratios (EBITDA/annual interest expense) of 4.8x EBITDA in 2015 is significantly higher than the historical average of 3.6x dating back to 2001. According to S&P Leveraged Loan Commentary & Data, earnings have been growing between 5–10 percent per year since 2012, on average. Recently, we have been buying select credits in retail that have been unfairly punished as a result of a few problem names in the industry; we are also finding opportunities in technology and media. We continue to take a cautious approach to energy and metals, but the opportunity to take advantage of a rebound should soon arise. We are also avoiding CCC-rated credits, and continue to favor B-rated loans, which we believe offer compelling value relative to BB-rated loans.

Average Loan Interest Coverage Far Exceeds Historical Average

Concerns stemming from commodity markets spilled over into the loan market in 2015. We believe the spillover will prove temporary. The underlying fundamentals in the loan market appear solid, evidenced by average interest coverage ratios of 4.8x EBITDA, which is well above the historical average.

Average Loan Interest Coverage Far Exceeds Historical Average

Source: S&P LCD. Data as of 9.30.2015.

—Thomas Hauser, 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, Transparent Value Advisors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.


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