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Slow interest rate retreat keep senior secured loans in frame for 2024
With uncertainty in the macroeconomic backdrop in the US and across the globe, and the direction of central banks will take on interest rates teetering on a knife edge, there has been ongoing focus on the potential implications for the senior secured loan market.
While that focus is warranted, given central banks have halted the upwards momentum of interest rates, concern about global banks’ ability to generate private credit income is misplaced according to global investment giants Invesco, who remain sanguine about the market. “While technicals are finding an equilibrium, market fundamentals for underlying issuers remain relatively strong,” the group states in a recent strategy insights note.
Foremost among several “compelling” reasons to have near-term faith in the sector, Invesco states, is that there remains potential for high levels of income in the senior secured loans market.
“Current income is comprised of two key components – base interest rates (which are expected to stay higher for longer) and credit spreads (which continue to remain wide). Coupon income for bank loans today is ~9.5 per cent, which is its highest since 20091,” Invesco says. “Market expectations are for rates to remain high, well above pre-2022 levels. Loans have proven to provide consistent, stable income through varying market cycles, including recessionary periods and periods of falling rates.”
The secured overnight financing rate (SOFR) forward curve, which represents the implied forward rate based on futures contracts and reflects future expectations of Federal Open Market Committee policy, also reflects low levels of loan risk, Invesco notes.
“Loans have virtually no duration risk (average ~45 days). The forward SOFR curve currently implies an average 3-month SOFR rate of approximately 4.5 per cent over the course of 2024. This reflects the broadly adopted market view that the US Federal Reserve (Fed) will pivot to easing interest rates in 1H 2024, but will lower interest rates cautiously.”
That cautious outlook taken by central banks in the US, and globally, means the the relative value of senior secured loans remains robust.
“Loans have offered one of the best yields in fixed income, while providing downside risk mitigation by being senior in the capital structure and being secured by the assets of the company. Loans have offered these high yields with no duration risk,” Invesco states.
“In a recessionary environment, loans offer downside risk mitigation by being senior which means they are the highest priority to be repaid in the event of default. Senior secured assets may offer added risk mitigation throughout recessionary periods.”
In the near to medium term, the group forecasts “ample opportunity” in the loan asset class to generate higher than average returns while maintaining the same minimal risk profile for investors.
“We expect 8 per cent loan returns in 2024, again powered by strong carry partly offset by expected price erosion at the lower end of the credit quality spectrum. An aggressive interest rate easing cycle is certainly possible based on historical experience, but that is not our base case.”
