Three reasons senior secured loans can shine through the uncertainty: Invesco
Uncertainty in the US macroeconomic backdrop over the calender year has put the spotlight on the fixed income market, with senior secured loans holding a strong position due to a confluence of reasons according to Invesco.
The senior secured loan market is challenged by some serious questions, with the most pressing focussed on the ability of underlying issuers to handle inflation pressures and whether they will be able to pass on increase costs to consumers.
Of course, where the US sits in the inflationary cycle and what effect a potential recession could have on investors are questions that will also play a role in the trajectory of senior secured loans.
In a market note released this month, the team at Invesco argue there are three primary reasons to believe senior secured loans will continue holding up.
The first of those involves the high level of income they’re bringing in.
“Current income is comprised of two key components – base interest rates (which are still increasing and expected to stay higher for longer) and credit spreads (which continue to remain wide),” the Invesco team stated. “Coupon income for bank loans today is ~9 per cent, which is its highest since 2009. The market is expecting at least one more rate hike in 2023, and market expectations are for rates to remain high, well above pre-2021 levels.”
Loans have proven to provide consistent, stable income through varying market cycles, including recessionary periods and periods of falling rates, the investment manager continued.
The second focal point for senior secured loans is the floating rate feature embedded in them, Invesco stated.
“Loans have virtually no duration risk (average ~45 days) and benefit from rising rates as coupons reset to higher base rates (LIBOR/SOFR). While there is uncertainty around the Fed’s policy to increase rates, the market is still pricing in more rate increases before plateauing towards the end of 2023. This environment benefits senior secured loan investors through higher coupon income.”
Most importantly, the team explained, senior secured loans offer compelling relative value that few products on the fixed income spectrum can match.
“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,” Invesco stated.
“Loans have offered these high yields with no duration risk. 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 as we enter a recessionary period.”