/institutional/perspectives/sector-views/bank-loans-watch-refi-risk-as-prices-improve

Bank Loans: Watch Refi Risk as Prices Improve

We believe loans offer attractive value to income seekers, but refinancing risk could resurface in 2021.

March 11, 2021


This Bank Loans sector report is excerpted from the First Quarter 2021 Fixed-Income Outlook.

The leveraged loan sector delivered a total return of 2.8 percent in 2020 as Fed rate cuts lowered coupon rates and downgrades pushed prices lower. Bank loans should be better positioned for stronger performance this year with price discounts in some industries, and the recent increase in Treasury yields renewing interest for duration protection among investors.

Discounted Loans Mostly Found in Energy, Leisure, Aerospace

Share of Index Trading at a Discount to Par, by Industry Loan Outstanding

Bank loans should be better positioned for stronger performance this year with price discounts in some industries, and the recent increase in Treasury rates renewing interest for duration protection among investors.

Discounted Loans Mostly Found in Energy, Leisure, Aerospace

Source: Guggenheim Investments, Credit Suisse, Bloomberg. Data as of 1.27.2021.

Issuance in the collateralized loan obligation (CLO) market is also forecast to be a robust $100 billion, not including refinancing and reset volumes.

Loan investors will need to watch out for refinancing risk in favored industries such as healthcare, technology, and food and drug, where most loans are trading at or above par. There is a strong correlation between refinancing activity and the share of loans trading above par.

Market Is Heating Up as Investors Bid Loans to Par or Above

There is a strong correlation between refinancing activity and the share of loans trading above par. By comparing secondary loan spreads and pricing in the new issue loan market over the last four months, we found around $90 billion of single B loans that are “in the money” to be refinanced later this year, with 101 basis points in potential spread savings to the borrower.

Market Is Heating Up as Investors Bid Loans to Par or Above

Source: Guggenheim Investments, S&P LCD, Credit Suisse. Data as of 1.27.2021.

By comparing secondary loan spreads and pricing in the new issue loan market over the last four months, we found around $90 billion of single B loans that are “in the money” to be refinanced later this year, with 101 basis points in potential spread savings to the borrower. The aforementioned favored sectors comprised roughly $40 billion of this refinancing risk.

Downward credit migration has notably eased. The three-month ratio of loans downgraded versus upgraded fell to only 1.1x in the fourth quarter, compared to 43x earlier in the year. In its wake, negative rating migration left behind a loan market with the highest exposure to CCCs or below since 2010, and 19 percent of loans rated B-, the highest ever. This credit profile presents some downside risk given that the average CLO portfolio rating profile is worse than before the pandemic, which gives them less room to absorb more downgrades. But a strong economic recovery should buoy corporate earnings, and possibly restore some ratings to their previous level. Barring an unexpected economic shock, we believe the current rating profile will not weigh on the market’s performance. And while discount margins have tightened from a March 2020 peak of 1,275 basis points to only 455 basis points , we see more room for further spread compression as spreads remain above the post-2008 tights of 381 basis points and pre-2008 tights of 230 basis points.

—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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.

©2021, 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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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 Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Fund Management (Europe) Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.