Bank Loans: Not Too Hot, Not Too Cold
Moving slightly down in quality as loans deliver steady performance.
The loan market has been relatively quiet over the past few months from an investor’s perspective, delivering not-too-hot, not-too-cold performance. Defaults remain largely constrained to the commodity sector (metals and energy represent 60 percent of default volume based on count and amount), which represents less than 5 percent of institutional loans outstanding. As such, the 12-month trailing default rate of 2 percent as of the end of June is well below the historical average of 3.8 percent. Institutional loan issuance of $121 billion has declined by 40 percent on a year-over-year basis, but soft demand is reflected in weak CLO issuance, as well as continued outflows from loan mutual funds.
Greater Upside Potential in Lower-Rated Bank Loans
The average price of loans in the Credit Suisse Leveraged Loan index is currently 93.9 percent of par, indicating some price upside in the loan market. However, reviewing the data by rating demonstrates that the biggest discounts—and therefore the most upside—are found in loans rated B or lower. As the highestquality segment of the loan market appears fairly priced, we have been opportunistically deploying capital in B-rated loans over BB-rated loans in order to benefit from returning market risk appetite.
Source: Credit Suisse, Guggenheim Investments. Data as of 7.21.2016.
Slow and steady, the Credit Suisse Leveraged Loan index delivered a relatively modest quarterly total return of 2.9 percent with limited volatility. The sector was largely insulated from the brief period of volatility that struck risk assets, with discount margins widening by only 14 basis points in the week that followed the historic Brexit vote. Ultimately, index margins ended tighter over the quarter by 39 basis points.
During the brief period of volatility, lower-quality loans sold off while higher-quality, BB-rated loan performance and valuations remained steady. More defensive sectors, such as consumer staples and healthcare, also performed better than more cyclical sectors. These varying performance trends make index-level statistics a misleading measure for value in the bank loan market. The average price in the Credit Suisse Leveraged Loan index was 93.9 percent of par at the end of June, which suggests loans have plenty of upside. Most of the total return upside, however, exists in B-rated and CCC-rated loans, which are trading at average prices of 96.4 percent and 79.1 percent of par, respectively (compared to BB-rated loans trading at 99.7 percent of par, on average). Therefore, we currently see more relative value in single B or lowerrated credits in the loan space.
Bank Loans Deliver Slow but Steady Performance
Bank loans, which are typically floating rate with relatively short durations, have underperformed other fixed-rate bond markets in 2016, but they have performed as we anticipated—delivering steady returns with limited volatility. We expect that the loan market will continue to deliver positive performance through the end of 2016, particularly as investors price in a higher probability of the Fed raising interest rates in the second half of the year.
Source: Credit Suisse, Barclays, Bloomberg, Guggenheim Investments. Data as of 7.28.2016.
—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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Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.