Seeking Alpha

Junk bonds a better play than bank loans

  • 'These record inflows into an ill-understood, more illiquid asset class present a danger to the value of loans if investors begin to reverse course and withdraw assets," writes Craig Sullivan of the $54.8B in inflows into bank loan funds YTD - more than triple the previous annual record in 2010 of $17.9B.
  • At the center of his argument is the perception that the floating-rate aspect of bank loans provides rate protection. These loans are typically of 5-9 year maturities, but the floating rate component is priced off of 90-day Libor. A rise in interest rates is of no benefit to the lender as long as the Fed holds short rates near zero. During the big move at the mid-long end of the curve in May and June, 90-day Libor actually fell 2 basis points - i.e., the price of the loan declined, but the yield went nowhere.
  • Also, most loans have Libor "floors," typically in the 150 basis points range. Good for lenders in that it provides some minimum yield, it also means - with 90-day Libor today at 26 bps - short rates will have to jump by 125 bps before the yield would move higher.
  • While the price movements of bank loans and high-yield bonds are fairly similar, high-yield index returns are ahead of bank loans by about 140 bps YTD, still carry higher yields, and offer call protection (bank loans typically offer none - when spreads drop they get refinanced). It's hard to make the case for choosing bank loans over high yield as long as short rates stay anchored near zero.
  • Bank loan ETFs: BKLN, SRLN, SNLN, FTSL.
  • High-yield ETFs: HYG, JNK, HYS, HYLD, SJNK, PHB, SJB, ANGL, XOVR, UJB, QLTC.
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